Mutual Funds Basics

While they were once unfamiliar investment options known only to a few people, mutual funds have managed to become something of a household name…and not just in investment circles either. The fact is, this now common investment option accounts for more than half of all the investments of the households in the United States. In fact, the combined value of all the investments in mutual funds has been estimated to be somewhere in the neighborhood of trillions of dollars.

It is important to keep in mind that there are many different kinds of mutual funds and each of them comes with their own risks and rewards. Generally speaking, the higher the potential return of a mutual fund, the higher its risk of loss is as well. Furthermore, while it is true that some mutual funds entail less risk than others, all mutual funds will have some degree of risk. And while diversification may help lessen the risk, they will not do away with it entirely.

Each type of mutual fund has an investment goal that governs its assets, investment regions and strategies. At the most basic level, there are three different types of mutual funds: equity funds (stocks), fixed-income funds (bonds), and money market funds.

All mutual funds are really just variations of these three types of funds. Equity funds are known as growth funds when they are invested in fast-growing companies for example. Equity funds that are invested solely in companies that are in the same region are commonly known as specialty funds.

Within these three broad classifications, there are many different varieties of mutual funds. Here are some of the most common types that you can expect to come across in order of the safest to the somewhat riskier:

Money Market Funds are mostly made up of Treasury bills and–to a lesser degree–a few other short-term debt instruments. This is by far the safest mutual fund that you can find, although they do have the disadvantage of offering lower returns than other types of investments. The main advantage with money market funds however is that you can be fairly certain that your principal will not be lost.

Bond/Income Funds are designed specifically to provide a regular income to the investor. When speaking of mutual funds, the terms “bond”, “income”, and "fixed-income," are usually used interchangeably. Whatever term is used, they all refer to investments in the areas of government and corporate debt.

Balanced Funds offer investors a good balance of financial security, a decent return on investment and the opportunity for capital appreciation. Balanced funds typically offer investors 60% equity versus a 40% fixed rate of income).

Equity Funds are by far the largest category of mutual funds. These investments are designed for long-term capital growth with some income as well.

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