The types of mutual funds: A guide

Mutual funds allow you to diversify your portfolio without the hassle of manually picking and managing individual investments. But how do you know which mutual fund is best for your situation?

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

First things first: What are mutual funds?

A mutual fund pools money from multiple parties 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, like brokers. Once you do, you become a partial owner of the fund’s entire portfolio, and as such, you are entitled to a proportional share of its 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 hands-on investment managers whose goal is to outperform the market. The managers make real-time decisions about when to enter and exit positions to maximize gains and minimize losses.

If you’re looking to outpace the market – and are comfortable with the added risk inherent in this approach – 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. Learn more about how mutual funds work, the fees involved and common terminology you may encounter.

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 – a common category of which is index funds – aim to mirror the performance of a specific market index (e.g., the S&P 500) or may follow a set of rules or a quantitative model to build a fund.

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

This management style requires less decision making and trading on the part of the fund, which generally translates to lower fees and fewer taxable events. It’s worth noting that with the potentially lower costs there may be less ambitious performance goals, at least compared to actively managed mutual funds.

What are the different types of mutual funds based on the investments 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 the distinction between active and passive management, mutual funds may be classified based on 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 (stock) mutual 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 strong long-term growth. A diversified portfolio of stocks has historically outperformed many other types of investments over time.

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 exit in the shorter term.

International and global mutual funds

Global mutual funds primarily invest in foreign companies but may also include U.S. holdings. International mutual funds, however, tend to invest exclusively in foreign companies. As with other types of mutual funds, the allocations within these funds can be broadly diversified or more specialized. When specialized, they tend to focus on certain foreign 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 (sector) mutual 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, may increase their risk; if a certain 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 be appealing to more conservative investors because they typically carry lower risk than equity funds. They also offer built-in diversification, a steady stream of income and potentially come with professional oversight if they are being overseen by active fund managers.

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 investments issued by the U.S. government, state and local governments and U.S. corporations.

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 good place for investors to park their savings.

Most money market funds aim to maintain a stable net asset value (NAV) as close to $1 per share as possible. While they usually succeed, there can be rare occurrences of “breaking the buck,” where a money market fund’s NAV dips below $1 due to extreme market stress. This 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.

As their name would suggest, balanced funds attempt to balance risk and reward through a mix of investments. The asset allocation of a balanced fund may provide more stability than investing in stocks or bonds alone, but these funds may come with fees and generally don’t generate returns as high as equity funds. They’re also subject to the risks associated with the instruments they hold.

The bottom line

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

The variety of mutual funds out there 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.

View Disclosures