Understanding Investment Funds in 5 Minutes (Yes, Really!)
You don’t need a finance degree to understand investment funds. Learning just a few basics can help you identify what you’re investing in or at least have an informed conversation with an investment professional. Knowing the different types can help you manage risk and feel confident about what’s happening with your money behind the scenes.
Quick Look at the Types of Funds
Funds are generally divided into three main types: mutual funds, closed-end funds, and exchange-traded funds (ETFs). They can be actively managed, with professionals trying to outperform the market, or passively managed, like index funds that track the market. However, this can all get a bit technical.
For this Good Read, we will focus on the primary objective of each fund type and what they aim to offer investors.
Aggressive Growth Funds
These funds aim for maximum long-term growth. They often invest in younger or fast-growing companies. Expect high potential returns along with considerable fluctuations. They usually generate little to no income (i.e., dividends), making them suitable for long-term investors with a higher risk tolerance.
Growth Funds
Growth funds also aim to increase your investments over time, usually with slightly less risk. They invest in established companies, often those that reinvest profits but may also pay some dividends. Returns mainly come from price increases rather than income.
Growth & Income Funds
These funds combine stock growth with more consistent income from dividends. They focus on companies with strong track records and dependable dividend payouts. The goal is still growth, but with more stability than pure growth funds.
Balanced Funds
A balanced fund combines stocks and bonds to provide both growth and stability. However, the aim is to protect more of your principal (depending on the bond allocation) while still giving access to stock returns. These funds often appeal to individuals who favor a simple, more diversified investment strategy.
Income Funds
If the goal is steady income, these funds invest in dividend-paying stocks and interest-generating bonds. They tend to be less volatile than the broader stock market, but their returns can fluctuate when interest rates rise or fall.
Bond Funds
Bond funds invest in government, municipal, or corporate bonds. Risk and return vary depending on the issuer and bond maturity. Note: Bond prices move inversely to interest rates. When rates rise, bond prices typically fall. Longer-term bonds tend to experience larger price fluctuations than short-term bonds.
Money Market Funds
These are the most conservative funds. They invest in short-term instruments like CDs and Treasury bills and aim to keep the share price at $1. They don’t grow much, but they focus on stability and liquidity.
Deciding Which Fund to Choose
Imagine you’re starting a new job and funding a 401(k). You browse through the investment options and see:
XYZ Growth Fund
ABC Growth & Income Fund
123 Income Fund
456 Money Market Fund
If you’re saving for retirement in the distant future, the growth fund could sound appealing, if not make sense, because you have time to ride out market ups and downs.
Or, say, based on your understanding of risk tolerance and a discussion with an investment professional, the decision might be a blend of the aggressive growth fund, income, and money market fund that meets your return requirements. Ultimately, knowing the purpose of each type helps you choose intentionally rather than guess.
Summary
Investment funds come in various types, but their goals are straightforward: growth, income, stability, or a mix of all three. When you understand each fund's purpose, choosing the right one feels less overwhelming. Set your goals, learn to read investment prospectuses, and select funds that align with your timeline and risk tolerance.
Disclaimer: Creek & Lyells Financial Literacy Foundation does not provide financial services, nor does it recommend or advise visitors to open accounts or buy or sell securities. All content on this blog is for educational purposes only. While we strive to provide accurate, relevant, and well-vetted information, visitors should consult a licensed financial professional and carefully evaluate the risks of any financial decision before taking action.