Do mutual funds invest only in stocks?
Mutual funds invest in stocks, but certain types also invest in government and corporate bonds. Stocks are subject to the whims of the market and thus offer a higher return potential than bonds, but they also present more risk. Bonds, by contrast, provide a fixed return that is usually much lower than what an investor gets from stocks. The advantage of bonds is they are low risk. Only in an extreme situation, such as the complete failure of a corporation, does an investor not receive the return he was promised from a bond security. A mutual fund's investment profile depends on the type of fund. There are three main types: equity funds, fixed-income funds and balanced funds.
Equity funds are mutual funds that invest only in common stock. They offer the biggest returns but also the highest risk. An equity fund, however, still presents a lower risk than investing in individual stocks. The reason is an equity fund is a bundle of hundreds or even thousands of stocks. It is diversified by its nature. If one company in the bundle tanks, the investor's exposure is very limited since his money is spread across hundreds of companies.
Fixed-income funds invest only in government or corporate bonds that offer fixed returns. These mutual funds are much less risky since they provide the same return whether in a bull market or a bear market. However, investors who choose fixed-income funds because of lower risk must also accept, in most cases, lower returns.
Balanced funds feature a mix of equity and fixed-income investments. Their return potentials and risk levels fall between that of equity funds and fixed-income funds. Balanced funds occupy a broad gamut. Some are stock-heavy, while others are comprised of mostly bonds and feature only a smattering of equities. Plenty of balanced funds exist from which to choose; diligent investors can almost always find one whose makeup corresponds with their risk tolerance and desired return potential.
A mutual fund is an investment company that pools money from many people and invests it in stocks, bonds, or other securities. Each investor owns shares; each share represents a tiny portion of each individual security held by the fund. An investment professional handles the purchase and sale of individual securities in the fund, based either on an index or on his or her professional expertise. Investors may buy shares (or portions) directly from the fund or through brokers, banks, or financial planning or insurance professionals.
With the majority of mutual funds, when you buy shares, you pay the current net asset value (NAV) (the value of one share in a fund), plus any sales charge (known as a sales load). As with individual stocks, the share price of mutual funds fluctuates and the value of an investment may be more or less than its original cost.
All mutual funds do not invest solely in stocks. They invest in a variety of assets such as bonds, real estate, and some even invest in commodities. You should carefully review the mutual fund prospectus in order to get an understanding about where and how the fund manager is investing the fund's assets.
Mutual funds are a way for many investors to pool their money together and hire a manager (and minions) to decide how to invest the money. Mutual funds (and ETFs, too) specialize in a variety of areas. Some are invested in only stocks, while others are only in bonds. Some invest in Real Estate Investment Trusts, and others invest in commodities contracts.
Often, you can tell what the investment is by the name of the fund. For example, the Vanguard 500 Index fund is invested in the S&P 500 list of the largest US stocks. The Northern Small Cap Value fund is invested in US Small companies. And the PIMCO Foreign Bond fund is invested in non-US bonds.
The fund specialty is not always in the name of the fund, so extra research is needed to find out what a mutual fund is about.
Then, there is the category of funds that invest in a little of everything. These are called Asset Allocation or Target Date funds. Here, there are many kinds of mutual funds (US large stock, US small stock, bonds, international) all wrapped up in one mutual fund. The idea is to make it easier for the investor to have a professionally managed mix of mutual funds without all the work.