Types of mutual funds: A guide to the 4 main categories

Mutual funds can help you diversify your portfolio without having to pick and manage individual investments yourself. But how do you know which mutual fund is best for your situation?

After you decide to invest in a mutual fund, the next step is choosing the type that best matches your needs, goals and preferences. In this guide, you’ll learn the pros and cons of key options – from stock and bond funds to global and international funds.

What are mutual funds?

A mutual fund pools money from multiple investors and invests it in a basket of securities and other assets. With the purchase of shares of a mutual fund, you can gain exposure to a variety of investments with a single purchase.

You can buy shares of a mutual fund through the fund itself or through intermediaries, such as brokerage firms.

Once you do, you own shares of the fund, which represent an interest in its underlying portfolio – so your returns generally reflect a proportional share of the fund’s gains and losses.

Active vs. passive mutual funds: What’s the difference?

One of the most important distinctions among mutual funds is how they’re managed: actively or passively.

Let’s walk through the differences between active and passive mutual funds.

Actively managed mutual funds

An actively managed mutual fund is overseen by portfolio managers whose goal is to outperform a benchmark or the broader market. They make ongoing decisions about what to buy and sell to pursue returns and manage risk.

If you’re looking to try to outpace the market – and are comfortable with the additional uncertainty that comes with manager decisions – this type of fund could be a fit. Note, however, that actively managed funds tend to come with higher fees and more taxable events than their passively managed counterparts. Fees can impact your returns and may vary by share class. You may also want to learn more about how mutual funds work, including fees and common terminology.

And remember, while the goal of actively managed funds is to outperform the market, there are no guarantees, and past performance doesn’t guarantee future results.

Passively managed mutual funds

Passively managed mutual funds – often called index funds – aim to track a specific market index (such as the S&P 500). Some also follow a rules-based strategy designed to closely track a defined benchmark.

Passively managed mutual funds usually don’t aim to outperform the market like actively managed funds – they typically aim to keep pace with it.

This approach generally requires less day-to-day trading, which often translates to lower fees and fewer taxable events. In exchange, the goal is typically to track a benchmark rather than outperform it.

Different types of mutual funds (based on what they hold)

Mutual funds may be helpful when you want to diversify your portfolio, but they aren’t a one-size-fits-all investment vehicle – there are many options to consider. Beyond active vs. passive management, mutual funds are often classified by the types of investments they hold.

Here’s a breakdown of some of the types of mutual funds, as well as the benefits and drawbacks of each.

Equity mutual funds (stock funds)

Equity mutual funds, also known as stock funds, invest primarily in equities, or stocks. Some equity funds are broadly diversified, spreading investments across many companies and sectors, while others focus on fewer companies or particular industries.

The standout benefit of equity funds is their potential for long-term growth. Over long periods, diversified stock portfolios have historically delivered higher returns than many more conservative investments.

In the short term, though, stock funds can be volatile, as they can be impacted by market swings, economic shifts and company-specific developments affecting the underlying positions that make up the fund. This potential for volatility can make them risky for investors who may need to sell in the short term.

International and global mutual funds

Global mutual funds invest in companies around the world, including those in the U.S., while international mutual funds generally focus on companies outside the U.S. Allocations can be broadly diversified or more specialized – often focusing on certain regions or countries.

The primary benefit of international and global mutual funds is geographic diversification, which can help offset losses if the U.S. market takes a downturn. They also open the door to growth opportunities in emerging markets.

International investing brings its own set of risks, though, as foreign investments can be negatively impacted by political and economic instability, currency fluctuations and varying regulatory standards.

Specialty mutual funds (sector funds)

Specialty mutual funds, also known as sector funds, invest in companies within a certain industry or sector of the economy, such as energy, utilities or real estate. In doing so, they give investors the chance to benefit from strong growth in a given sector.

The narrow focus of sector funds, however, can increase risk; if a sector underperforms, your returns could take a harder hit than they would with more broadly diversified funds.

Bond mutual funds

Bond mutual funds invest primarily in bonds and other types of debt securities. For example, they may include or focus on government bonds, municipal bonds, corporate bonds, zero-coupon bonds or mortgage-backed securities.

These funds can appeal to more conservative investors because they often carry less volatility than stock funds, though risk varies depending on the underlying bonds. They can also offer diversification and income potential.

On the flip side, however, bond mutual funds may have less growth potential than equity funds. They’re also sensitive to interest rate changes (bond prices tend to fall when interest rates rise) and credit risk (if a bond issuer defaults, you could face losses).

Money market mutual funds

Money market mutual funds invest in certain short-term, high-quality securities issued by the U.S. government, state and local governments and U.S. corporations. They generally focus on liquidity and stability, but they can still lose value.

Here’s a closer look at these types of money market funds:

Money market funds generally carry less risk but offer lower returns than other types of mutual funds, including bond and equity funds. They’re known for their stability and liquidity, which can make them a place some investors use for short-term cash holdings.

Most money market funds aim to maintain a stable net asset value (NAV) of $1 per share, although certain institutional funds have floating NAVs. Stable-NAV funds can, in rare cases, “break the buck,” meaning their value falls below $1 per share, while floating-NAV funds may fluctuate in value. Both can result in losses.

Balanced mutual funds

Balanced mutual funds invest in multiple asset types, including stocks, bonds and sometimes money market instruments. Investment allocations vary by fund. For example, one fund may contain 50% stocks and 50% bonds, while another could have 60% stocks and 40% bonds.

Balanced funds aim to balance risk and reward through a mix of investments. The asset allocation of a balanced fund may help manage risk through diversification, though returns vary based on the fund’s investments and market conditions. They’re also subject to the risks associated with the instruments they hold.

The bottom line

All mutual funds pool money from multiple investors to invest in a portfolio of securities and other assets. The allocations within the funds – and how they impact your portfolio – can vary widely. The mutual fund that makes sense for you will depend on several factors, including your goals, risk tolerance, time horizon, preferred management style and fees, which can affect overall returns.

The variety of mutual funds available means you don’t have to stick with just one type. In fact, combining different types of mutual funds in your portfolio could help you build a well-rounded investment strategy that supports a range of financial goals, from long-term growth to steady income.

Lastly, as you weigh mutual fund options, be sure to review the fund’s prospectus and most recent shareholder report. These documents provide insights into the fund’s strategy, holdings and past performance.

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