Mutual funds are normally classified by their principal investments, which are described in their prospectus and investment objectives. The four general categories for funds in the market are money market funds, bond or fixed income funds, equity funds, and balanced funds.
Money Market Fund
Money market funds invest in money market instruments, which are fixed income securities with a very short time to maturity and are generally high in credit quality. Investors often use money market funds as a substitute for bank savings accounts, though money market funds are not insured by the government, unlike bank savings accounts. Compared to other types of mutual funds, a money market fund is commonly considered a low risk instrument to park your cash while waiting for an investment opportunity.
Typically, the type of securities that a money market fund will invest in are short-term. Examples are government notes, federal agency notes, Eurodollar deposits, repurchase agreements, certificates of deposits, corporate commercial paper; and obligations of states, cities, or other types of municipal agencies.
Fixed Income Fund
Fixed income funds invest in fixed income or debt securities. Fixed income funds generally pay a return on a fixed schedule, though the amount of payment can vary. Investors may consider this for income generation and capital preservation.
Fixed income funds usually generate higher return than money market funds and may be appropriate for conservative investors seeking regular cash flow. This type of fund is also a good choice for adding diversification to any investment portfolio.
Equity mutual funds invest primarily in common stocks and represent the largest category of mutual funds. Some equity funds only invest in companies from a specific country or industry while others can invest broadly in any country or industry. Equity funds generally have the widest range of strategies compared to all other asset classes.
Equity funds are usually more volatile than money market or fixed income funds, however, they also offer the highest potential returns. While a stock’s value may rise and fall quickly over a short period of time, history has shown stocks to perform better over the long term than other types of investments, such as bonds and money market instruments.
They are best suited for investors who are seeking long term growth.
Balanced funds invest primarily in equities and fixed income securities, shifting assets among stocks, bonds and money market instruments depending on current market conditions. Balanced funds are intended to provide a balanced mixture of safety, income and capital appreciation. Balanced mutual funds are affected by interest rate changes, stock market performance, and economic outlook.
Another similar fund would be an asset allocation fund, which maintains comparable objectives to balanced funds, but which typically do not hold a specified percentage of any asset class. In asset allocation funds, the portfolio manager is usually free to hold whichever assets, in whatever amounts he or she determines may best benefit from current and future market trends.
Balanced funds may be appropriate for investors seeking a more diversified portfolio by investing in one fund.