Mutual Fund Education Center This section covers mutual fund education designed to help
beginners and professionals alike. There are many aspects of mutual funds an investor should understand before
a mutual fund purchase is made. The information below will help you understand the difference between mutual fund
categories and the different "types" within a category.
Mutual fund categories
Mutual funds fall into the following categories: money market funds, bonds funds, stocks funds, balanced
funds, and asset allocation funds.
Stock funds
As the name implies, stock mutual funds invest mainly in common stocks. These stocks may be sold on the New
York Stock Exchange, the NASDAQ or other exchanges.
The objective of a stock fund is long-term capital appreciation versus generating income (dividends) more common
with bond funds. However, stock funds may generate modest dividends from the stocks in the portfolio and
from short-term cash investments. These stock tend to be larger capitalized stocks versus smaller growth
stocks.
There are four basic types of stock funds.
Stock Fund Types
Large Cap: Primarily invests in "Blue-chip" companies - large, well-known industrials,
utilities, technology, and financial services companies with large market capitalization. Large cap stocks
are perceived to be less risky than smaller capitalized companies
Mid Cap: Primarily invests in companies whose market capitalization is smaller than large caps
but larger than small caps. Mid caps are generally considered more risky than large cap stocks but
have a higher return expectation
Small Cap: Primarily invests in emerging companies, thought to have potential for future growth
and profit. Small caps are generally considered the riskiest stocks compared to larger capitalized firms
but carry the expectation of higher returns. Small cap funds are subject to greater volatility than those
in other asset categories.
International: Primarily invests in stocks traded on foreign exchanges but purchased in
the United States by U.S. fund companies. International funds are subject to additional risks such as currency
fluctuation, political instability and the potential for illiquid markets.
Sector: Primarily invests in specific industry sectors such as technology, financials,
health, or energy. Since sector funds focus their investments on companies involved in a specific industry
sector, the funds may involve a greater degree of risk that an investment in other mutual funds with greater diversification.
Many investors buy stock mutual funds because, historically, stocks have outperformed other types of investments
over the long term. However, the value of the stocks in the fund's portfolio may go up or down as the market rises
or declines. Remember, past performance is no guarantee of future results.
Bond funds
Bond funds1 invest in various types of bonds - issued by corporations, municipalities, and the U.S.
government. Bond mutual funds are
designed mostly to provide investors with a steady stream of income2 versus capital gains.
Bond Funds:
Invest in bonds, which are debt securities, or IOUs, issued by corporations or governments in exchange for
money loaned to them. Generally, the issuer agrees to repay the loan by a specific date and to make regular interest
payments to the lender until then.
Are a basket of bonds with different durations, yields, credit quality, and values. Because of this,
bond funds never mature as would be the case with buying an individual bond.
Share value and dividends will fluctuate as interest rates fluctuate and new bonds are purchased or others
are sold or mature.
Produce profits that consist primarily of dividend distributions.
May generate modest capital gains.
Fluctuate in value, so it is possible to sell shares at a higher or lower price than you paid for them.
Bond Fund Types:
Government: Primarily invest in bonds issued by the U.S. Department of Treasury as well
as various federal agencies. Government bonds are generally taxable.
Municipal: Primarily invest in municipal bonds issued by state and local governments and
their agencies to fund projects such as schools, streets, highways, hospitals, bridges, and airports. Municipal
bonds can be insured or non-insured securities. Income generated from municipal bonds may be tax free at
both the federal and state level (consult the funds prospectus).
Corporate: Primarily invest in bonds issued by corporations to help fund business activities.
Income from corporate bonds is taxable.
1 Bond fund shares are not guaranteed and will fluctuate with market conditions and interest rates
and include a greater risk to principal than Certificates of Deposit. Shares, when redeemed, may be worth more
or less than their original cost.
2 Income may be subject to the Alternative Minimum Tax (AMT) and capital appreciation from discounted
bonds may be subject to state and local taxes.
Money market funds
Money market funds invest in short-term securities such as Treasury bills. Most money market funds offer a higher
rate of interest than bank savings accounts, and some are free of federal or state taxes. But unlike bank savings
accounts, money market funds are not FDIC insured.
Money market mutual funds are designed to be more stable than stock or bond funds. Money market funds are designed
to provide steady dividend income on the investment amount, although the yield may fluctuate daily.
Taxable: Invest in short-term obligations from corporations.
Tax-free: Invest in short-term obligations from government entities.
Balanced Funds:
Invest in stocks, bonds, and cash investments, in varying proportions.
Produce dividend and capital gain distributions and share price appreciation in proportion to their allocation
among the three major asset classes.
Asset Allocation Funds:
In an asset allocation fund, the manager will diversify the assets among each category: cash, bonds, and stocks
and weight them according to the portfolio strategy. The manager will redistribute the weightings according
to market conditions. Portfolio strategies generally differ according to risk tolerance:
Aggressive Growth Strategy Portfolio
Growth Strategy Portfolio
Growth and Income Strategy Portfolio
Income Strategy Portfolio
Asset allocation funds are usually made up of a combination of other mutual funds within the same fund family.
As market conditions change, the manager has the discretion to reduce exposure in one fund and increase it in another.
Just about all mutual fund families allow you to switch between funds in the same family and class (A, B, or C shares) without incurring any costs.
