Mutual Funds Terminology Explained

Reviewed: November 06, 2014
By FinanceWeb

Mutual Fund Objectives

Mutual funds deal in stocks, bonds, and money market instruments. Their goals are to produce equity, steady income, or a blend of each. Income funds often hold large amounts of bonds, and equity funds focus on stocks that can gain in value. Money market funds provide returns that exceed savings account rates and are similar to CD rates with the potential to go much higher.

Advantages of Mutual Funds

Mutual funds provide investment safety, predictable income, and planned growth in value. There are essentially three types of mutual fund, money market, equity, and income funds. Money market funds provide income and protection against loss of principal investment. Equity investments, such as stocks, promote growth in the value of holdings along with some income. Income producing investments are usually made primarily of bonds, and these investments produce a steady stream of income for investors. When selecting mutual funds, investors often seek to balance risk with income and growth.

No Load Mutual Funds

Many investors feel discomfort in making investment decisions because they do not have time or expertise in stock and bond matters. However, others determine that paying for managers eats away at profits and should be avoided. Those who wish to minimize professional expenses can choose no-load mutual funds. No-load funds do not charge significant sales commissions and management fees. Many studies show that no-load funds out-perform load funds over a long period.

Indexed Funds

Indexed funds are an important category for investment, and it has two related effects. An index is an investment approach that seeks to emulate an existing broad group of stocks and thereby duplicate its performance. The S&P 500 and the Dow Jones Industrial Average are examples of indexes. An indexed mutual fund selects a group of stocks that are similar to these indexes, and which produce similar value or income. The second aspect is management. Active management absorbs income that could otherwise go to the investors. Indexed funds use the market to make investment decisions and therefore require less active management. In a sense, the use of the index is an investor decision that management would not fare better that the performance of a broad group of stocks. Indexed funds are a type of passive management, where guidelines drive investment decisions.

Actively Managed Funds

The opposite of an index fund is an actively managed fund. These funds have leading managers who use human judgment as the driver in investment decisions. They often have personal theories for reading trends and individual stock choices. For example, some leading actively managed funds use indicators to point to investment candidates. An example is looking for stocks in which insiders buy a large amount of stock. This behavior is an indication of value that exists, but that is not widely known.

Specializations and Focus

An alternative to a broad index is a focused investment style. Many mutual funds buy in narrow categories. While this investing limitation increases the risk of a dramatic downturn, it also permits investors a chance to ride an upswing in a particular part of the market. Focused areas include categories like international bonds, emerging technologies, health, and insurance. Investors may feel strong on growth and understand the risk that a downward trend can affect a narrow area more intensely than a broad selection of assets.

Socially Conscious Investing

Investors can select mutual funds that exclude issues they do not wish to support and include those they wish to strengthen. A familiar example is the exclusion of tobacco and tobacco products from a mutual fund portfolio. Investors can find mutual funds that perform well in terms of their objectives, but exclude certain areas of investment. Today the list includes climate impacts from fossil fuels, nuclear power, and alcohol consumption. The lists of available funds include those that promote issues such as fair trade, water rights, sustainable economics, and renewable energy.