Mutual funds can be classified into several sub-groups: types of funds, open-end vs. closed-end and share classes. An investor who chooses to invest in mutual funds should understand the various differences between funds to ensure that their goals and objectives are inline with those of the fund. Types of funds and open-end vs. closed-end are discussed below.
Please note that the funds listed below are the most common types of funds. These may be referred to by other names or can be broken down further, however, these should be the more common names and types you will hear.
This type of fund invests in stocks in order to provide capital appreciation over the long-term. These funds can be considered volatile because they tend to rise in bullish markets and drop in bearish markets. There is some dividend income.
Aggressive Growth Fund
This type of fund tends to offer maximum capital appreciation. These companies typically have a high potential for growth, and therefore, can have high price volatility. Dividends usually are not paid.
Growth and Income Fund
This is a type of fund that not only seeks growth, but income as well. The main investments in this type of fund are usually the common stocks of companies that have solid growth rates, as well as a history of consistent dividend payouts.
Bond (Income) Fund
This type of mutual fund invests in “income-producing” instruments for investors who require more income and who are less concerned with growth of assets; therefore, preservation of principle. A bond fund may specialize in a particular type of bond such as government bonds, municipal bonds, mortgage-backed securities, as well as corporate, convertible, foreign bonds and zero-coupon bonds, or it may invest in a variety of the aforementioned.
- Corporate Bond Funds—Invests in bonds of U.S. companies
- GMNA Bond Funds—Invests in mortgage backed securities
Municipal (Tax-Free) Bond Fund
This fund invests in bonds issued by municipalities and states. The income is U.S. federal tax-free.
High-Yield or Junk
This type of fund invests in non-investment grade (BBB or lower) for more income potential. This type of fund has lower ratings than the high-quality corporate or government bond funds. The risk of default is higher with a greater degree of volatility.
This type of fund invests in a variety of instruments such as common stock, preferred stock, and bonds. Its objective is a balanced approach, combining high return (stock) with low risk (bonds).
Money Market Fund
This type of fund invests in highly liquid securities for shorter-term needs of investors, for a modest return. Types of instruments purchased by money markets include government bonds, certificate of deposits, banker’s acceptances, commercial paper and repurchase agreements.
Specialized (or Sector) Fund
This type of fund concentrates its investments in one industry or a group of related industries. This type of investment is most appropriate for an investor who wants exposure to one particular industry (example: health, financial, telecommunications, etc.).
This type of fund has a portfolio matching that of a broad-based portfolio, for example, the S&P 500 Index. An index fund can be a stock fund, bond fund, foreign or indices of mid or small capitalization stocks. Expenses on these are typically low, as the only real buying and selling is to invest new cash, or liquidate current investors.
This type of fund invests in companies held outside the United States.
This type of fund invests in securities traded worldwide, including that of U.S. securities.
Open-End versus Closed-End:
An important distinction needs to be made between open-end funds and closed-end funds. Only open-end funds are truly mutual funds. This is a common misconception among investors. It is important to remember that only open-end mutual funds allow the investor to redeem shares at the true net asset value. Closed-end funds can either trade for a premium or discount, i.e., investors may pay/receive either more or less than the actual value of the underlying investments in the fund when they buy/sell shares. Characteristics of open-end and closed-end investments are as follows:
Open-end Investment Company
- Makes a continuous offering of its shares to the public;
- Number of shares outstanding constantly changes;
- Redemption price, purchase price is the actual Net Asset Value of the fund. The NAV is determined by the value of the underlying securities in the fund;
- Shares may be purchased or redeemed by issuing company, underwriter or dealer, and
- The cost: usually a sales charge is added to the NAV to determine the purchase price, unless the fund is “no-load.”
Closed-End Investment Company
- Makes a one time offering (a limited offering) of its shares, which are not redeemable by the issuer. The company issues shares of common stock to raise capital and builds a portfolio of securities per the funds investment objective. Only a limited number of shares are issued to raise the capital;
- Because the offering is limited, or usually one time, the number of shares outstanding is a fixed amount;
- Shares are traded over the counter or on an exchange;
- Shares are bought or sold the same as any common stock. It can be purchased from another stockholder or from dealer inventory and a commission normally applies, and
- The share price is determined by supply and demand.
At Henssler Financial, our investment philosophy states that if you have less than $50,000 to invest, mutual funds are a more viable option to help you formulate a well-diversified portfolio. Our firm recommends various stock funds for investors seeking capital appreciation. In most cases, we recommend avoiding balanced funds, as these funds are really a combination of an equity fund and a bond fund. We also recommend avoiding most bond funds. Our approach states that bonds should be held when an investor expects to need funds at a certain date in the future. Bond funds, unlike bonds, have no guarantee of a specific maturity value on a specific maturity date. Money market funds are appropriate for short-term funds, or emergency reserves. In most cases, we avoid specialized funds, as the fees associated with these funds are often high.
We generally avoid closed-end funds. From time to time, a closed-end fund selling at a large discount may offer a compelling value, and should be considered for purchase. However, in most cases, mutual fund investors should stick with open-end mutual funds.
In a few weeks, we will review the fees and expenses associated with mutual funds, and address the misconception that a no-load fund is “free.” We will also discuss the different classes of shares in a mutual fund. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or [email protected].