Mutual funds are one of the most popular investment vehicles for both individual and institutional investors. As pooled investment vehicles, mutual funds allow investors to access a diverse portfolio of securities managed by professional fund managers. With the wide variety of mutual fund strategies and structures available, it is important for investors to understand the key examples of mutual fund investment options. This provides investors the knowledge to select mutual funds aligned with their financial goals and risk tolerance.
Actively managed mutual funds follow an investment strategy to beat the market
Actively managed mutual funds aim to outperform their benchmark index through security selection and trading by fund managers. Fund managers conduct research to identify undervalued securities to purchase and overvalued securities to sell short or avoid. The goal is to generate alpha, exceeding the return of the market.
For example, a large cap equity fund would aim to outperform a large cap equity index like the S&P 500. The fund manager researches companies in the index, constructing a portfolio expected to provide higher returns through overweighting securities expected to outperform and underweighting or avoiding those expected to underperform.
Index mutual funds follow a rules-based passive investment approach
Index mutual funds seek to match the performance of a market index like the S&P 500 rather than outperform it. They follow a passive investment approach, buying and holding the securities in the index in proportion to their index weights.
For example, an S&P 500 index fund would hold shares of all 500 companies in the index. As the prices of securities in the index rise and fall, the index fund’s net asset value moves correspondingly.
Index funds offer broad market exposure at low cost compared to actively managed funds. Since minimal research and trading is involved, the fees charged to investors are lower.
Target date mutual funds automatically adjust asset allocation over time
Target date mutual funds provide investors with a diversified portfolio that automatically rebalances to become more conservative as the target retirement year approaches. Early on, with a longer time horizon, target date funds allocate more to equities for growth. As retirement nears, the allocation shifts toward more fixed income for capital preservation and income generation.
For example, a 2050 target date fund today would hold about 90% in global equities across stocks, real estate, and other growth assets. As 2050 approaches, it will gradually reduce equity exposure to around 40% and increase fixed income to around 60%.
Balanced mutual funds maintain set ratios between asset classes
Balanced mutual funds, also known as allocation funds, invest in a stable mix of equities and bonds to provide a blended return. The equity component provides growth while the fixed income portion provides steady income and stability.
A common allocation is 60% equities and 40% bonds. Fund managers rebalance periodically to maintain the target allocation. Balanced funds appeal to conservative investors seeking a simple, pre-mixed asset allocation fund.
Sector mutual funds concentrate investments in specific sectors
Sector mutual funds focus their investments on companies operating in a particular industry sector rather than holding a diversified portfolio. Sectors targeted include technology, healthcare, financials, energy, utilities, and real estate among others.
Sector funds allow investors to overweight desired sectors expected to outperform. However, concentrating in narrow sectors increases risk compared to diversified funds. Sector funds are therefore best suited for tactically timing sectors as satellite holdings in an otherwise diversified portfolio.
Mutual funds provide investors access to professionally managed portfolios across a range of strategies. Key examples include actively managed funds seeking to beat the market, passive index funds tracking market benchmarks, target date funds adjusting allocations over time, balanced funds maintaining set asset class mixes, and sector funds focused on specific industries.