Mutual funds invest in stocks, but certain types also invest in government and corporate bonds. Stocks are subject to the whims of the market and thus offer a higher return potential than bonds, but they also present more risk. Bonds, by contrast, provide a fixed return that is usually much lower than what an investor gets from stocks. The advantage of bonds is they are low risk. Only in an extreme situation, such as the complete failure of a corporation, does an investor not receive the return he was promised from a bond security. A mutual fund's investment profile depends on the type of fund. There are three main types: equity funds, fixed-income funds and balanced funds.
Equity Funds
Equity funds are mutual funds that invest only in common stock. They offer the biggest returns but also the highest risk. An equity fund, however, still presents a lower risk than investing in individual stocks. The reason is an equity fund is a bundle of hundreds or even thousands of stocks. It is diversified by its nature. If one company in the bundle tanks, the investor's exposure is very limited since his money is spread across hundreds of companies.
Fixed-Income Funds
Fixed-income funds invest only in government or corporate bonds that offer fixed returns. These mutual funds are much less risky since they provide the same return whether in a bull market or a bear market. However, investors who choose fixed-income funds because of lower risk must also accept, in most cases, lower returns.
Balanced Funds
Balanced funds feature a mix of equity and fixed-income investments. Their return potentials and risk levels fall between that of equity funds and fixed-income funds. Balanced funds occupy a broad gamut. Some are stock-heavy, while others are comprised of mostly bonds and feature only a smattering of equities. Plenty of balanced funds exist from which to choose; diligent investors can almost always find one whose makeup corresponds with their risk tolerance and desired return potential.
Advisor Insight
Kristi Sullivan, CFP®
Sullivan Financial Planning, LLC, Denver, CO
Mutual funds specialize in a variety of areas. Some are invested only in stocks or bonds, while others invest in real estate investment trusts, commodities contracts, etc.
Often, you can tell what the fund invests in by its name. For example, the Vanguard 500 Index fund is invested in the S&P 500 Index, which includes the 500 largest U.S. stocks. The PIMCO International Bond fund is invested in non-U.S. bonds.
The fund's specialty is not always in the name of the fund, so extra research is needed to find out what a mutual fund is about.
There are also funds that invest in a little of everything. These are called asset allocation or target-date funds. The idea is to make it easier for the investor to have a professionally managed mix of mutual funds without all the work.
FAQs
Remember that a mutual fund or ETF isn't itself the investment, but rather they're the vehicles that allow you to invest in stocks, bonds or other securities. A fund can only be as good as the investments it holds, so be sure to understand how a mutual fund or ETF is invested before making a purchase.
Which are a better investment stocks or mutual funds explain your answer? ›
Key Takeaways. Mutual funds diversify investments, reducing risk, but also limit potential gains. Mutual funds are managed by professionals, reducing the need for monitoring, but investors give up control. Stocks offer higher returns but come with higher risk and volatility.
What is the #1 reason investors prefer mutual funds for investing? ›
One of the primary benefits is diversification, which reduces the risk of loss by spreading investments across a wide range of assets. Mutual funds also provide professional management, allowing you to leverage the expertise of fund managers who make investment decisions based on their research and analysis.
Why would someone choose to use a mutual fund instead of single stocks? ›
The primary reasons why an individual may choose to buy mutual funds instead of individual stocks are diversification, convenience, and lower costs.
What is a mutual fund that invests solely in stocks? ›
Equity income funds invest in stocks that regularly pay dividends. Stock index funds are passively managed funds that attempt to replicate the performance of a specific stock market index by investing in the stocks held by that index.
Do mutual funds invest in bonds? ›
Mutual funds let you access a wide mix of asset classes, including domestic and international stocks, bonds, and commodities.
Is it better to invest directly or in mutual funds? ›
Direct mutual funds typically have a higher NAV due to their lower expense ratio. This lower expense ratio in direct funds allows a larger portion of your investment to actively generate returns, potentially leading to higher overall returns compared to regular funds with higher expense ratios.
Is it safer to invest in mutual funds or individual stocks? ›
Investing in ETFs or mutual funds can be less risky than investing in individual securities. You can complement the ETFs or mutual funds in your portfolio with specific stocks and bonds.
Which is more risky mutual funds or stocks? ›
Investing in stocks and mutual funds can offer inflation-beating returns, with stocks being riskier than mutual funds. Mutual funds are managed by professionals and offer diversification. Equity funds suit those seeking passive investment, while ELSS provides tax benefits.
What is one downside of a mutual fund? ›
Cost: A mutual fund may incur sales charges either up-front or on the back end that are passed on to the investors. In addition, some mutual funds can have high management fees. Tax implications: Dividends and interest payments are generally considered taxable income by the IRS even if you reinvest the money.
For many investors, it can make sense to use mutual funds for a long-term retirement portfolio, where diversification and reduced risk are important. For those hoping to capture value and potential growth, individual stocks offer a way to boost returns, but come with more volatility.
What are the 4 types of mutual funds? ›
The majority of mutual funds can be classified into four primary categories: Bond funds, Money Market funds, Target date funds, and Stock funds. Each category possesses distinct characteristics, risks, and potential returns. Below is a comprehensive enumeration of mutual fund types.
Which one is better, stocks or mutual funds? ›
Mutual funds pose relatively lower risk than direct stock investing due to diversification. Shares have a higher level of risk compared to mutual funds. The debate of the stock market vs mutual funds is never-ending. You should know the pros and cons of both these options before choosing the right one for you.
Is it OK to invest only in mutual funds? ›
However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end and back-end load charges, lack of control over investment decisions, and diluted returns.
Which mutual funds outperform the S&P 500? ›
The top performing funds that beat the S&P 500 in Q1
| Fund | Q1 Return (%) |
|---|
| Alger American Asset Growth | 15.74 |
| iShares S&P Mid Cap 400 Growth ETF | 15.37 |
| Artisan US Focus | 15.32 |
| William Blair SICAV U.S. Large Cap Growth | 15.11 |
11 more rowsApr 5, 2024
You generally can withdraw money from a mutual fund at any time without penalty. 7 However, if the mutual fund is held in a tax-advantaged account like an IRA, you may face early withdrawal penalties, depending on the type of account and your age at the time.
Can you sell mutual funds anytime? ›
Mutual funds don't trade like stocks and ETFs, which can be bought and sold at any time during the trading day. Mutual funds can only be bought and sold after the market closes at the fund's net asset value (NAV).
What is the 30 day rule for mutual funds? ›
The 30-day rule is a guideline that applies to mutual funds. It states that if you sell shares of a mutual fund and then buy them back within 30 days, the transaction is considered a “wash sale” and you cannot claim a loss on your taxes for that sale.
