When investing in mutual funds, enlisting the aid of a financial advisor has many benefits. One drawback, however, is it removes you from the investment equation. When you defer to the guidance of a professional, you tend to lose touch with how your money is being invested and focus more on the simple net profit or loss reported at the end of the year.

You may think that if you make a profit, your advisor must be choosing the right products, or she might be doing something wrong if you suffer a loss, but this is not always true. Unfortunately, no matter how talented or lucky your financial advisor may be, she cannot always predict the market. However, she should still choose mutual funds that align with your specific investment goals. By understanding the different types of mutual funds and how they can be tailored to suit differing goals, you are better equipped to ensure your advisor's investing style is properly aligned with your own.

Investing Goal: Principal Preservation

Many people choose to invest in mutual funds because they can offer a high degree of stability. If your chief investing goal is to preserve your initial capital in exchange for slower growth, your financial advisor should recommend bond or money market funds. Though these types of mutual funds are not big money-makers, they offer a much higher level of security than other types of funds, and are suitable for investors looking to grow their wealth over time without taking on too much risk.

Bond Funds: Moderate Risk

Bond funds, as the name implies, include investments in a variety of bonds. In general, bonds are considered very safe, stable investments. Once a bond reaches maturity, the issuing company must pay the bondholder, in this case, your mutual fund, the full par value of the bond even if the bond was purchased at a discount. Unless the issuing entity defaults on the bond or the fund manager decides to sell it at a loss prior to maturity, the fund is guaranteed to recoup its initial investment.

Of course, there can be some risk involved if the issuing entity defaults and declares bankruptcy, or if your fund attempts to increase yields by trading bonds frequently rather than holding them until maturity. However, this can be largely eliminated by investing in mutual funds that only hold highly rated bonds and employ a buy-and-hold strategy.

Money Market Funds: Minimal Risk

Money market funds are the most secure type of mutual funds. If you are highly risk-averse and do not need to see huge returns each year, your financial advisor should recommend money market funds.

Like bond funds, money market funds invest in debt securities such as bonds, bills and notes. However, money market funds include only short-term securities, most often issued by governments or municipalities, that have maturities of less than one year. They may also include very short-term corporate debt, called commercial paper, but are only able to invest the most highly rated securities with the lowest possible risk. Because the likelihood of a government or highly rated corporation defaulting on its debts is so low, money market funds are almost risk-free.

Investing Goal: Income Generation

If your primary goal is to create consistent investment income throughout the year, your financial advisor should direct you to bond funds or dividend-bearing stock funds. The type of fund that is best for you depends largely on your risk tolerance.

Bond Funds: Moderate-Risk Income

A bond fund typically pays regular dividends as a result of the interest generated by the bonds in its portfolio. How often your fund pays dividends is dictated by the investment firm, but all mutual funds are required to pass on nearly all net income from investments at least once a year. If bonds in your fund make coupon payments monthly, you may receive dividends from your fund monthly as well. There are a variety of bonds funds available, and some can be very risky due to investment in low-rated bonds in the pursuit of higher yields. Be sure the fund your advisor chooses matches your risk tolerance level.

Stock Funds: Higher-Risk Income

If you are more risk-tolerant and are willing to gamble your capital for a chance to make big gains while earning regular investment income each year, your advisor should put your money into dividend-bearing stock funds. Not all stocks pay dividends each year, but many companies pride themselves on issuing consistent, and sometimes increasing, dividends each year. Many mutual funds specialize in investing in stocks that pay consistent dividends to attract investors looking to generate regular income.

Investing Goal: Aggressive Growth

Perhaps you have a nicely diversified portfolio and are willing to take on a substantial amount of risk in your mutual fund investments to really grow your wealth. If your chief goal is to generate large capital gains, your advisor should look into aggressive stock funds.

Because the volatility and associated risk of individual stocks can vary so widely, some stock funds are riskier than others. While risk may sound like something to be avoided, it is actually the mechanism that allows investments to generate huge returns. A low-risk investment has little room to grow, while a high-risk investment carries the increased possibility of failure and success.

Mutual funds that invest in the darlings of Wall Street, such as Amazon.com, Inc. or Netflix, Inc., are great for growth. Even better are funds that try to pinpoint the next big superstar and buy in early. If the fund manager chooses incorrectly, you may suffer a substantial loss. If he chooses well, however, the benefits of taking big risks quickly become apparent.

Investing Goal: Tax Efficiency

Any time your mutual fund issues a distribution, you must include that income on your yearly tax preparation. Whether that income is taxed at your ordinary income tax rate or at the lower capital gains tax rate depends primarily on how long the fund has held the investment.

Capital gains distributions, which are generated when your fund makes a profit on the sale of an asset, are taxed at your normal income tax rate unless the fund has owned the asset for a year or more. Dividends distributions are also typically taxed as ordinary income.

If your goal is to limit your tax liability, your financial advisor should invest in funds that are highly tax-efficient. This means choosing funds with low turnover ratios, meaning they do not buy and sell assets often. In addition, tax-efficient funds do not include dividend-bearing stocks or interest-bearing bonds because these securities result in taxable dividend distributions each year.

Some funds invest only in government or municipal bonds because they generate interest that is not subject to federal income tax. However, if your advisor directs you to a tax-free fund, be sure to clarify whether your earnings are still subject to state or local taxes.

The Importance of Fiduciary Duty

If you are assessing the performance of your financial advisor and find she has not been recommending products that suit your goals, you may want to confirm she is bound by fiduciary duty. Fiduciary duty is the most important legal obligation and serves to protect individuals in various financial and legal situations. Professionals who are bound by fiduciary duty, such as attorneys and legal custodians, are obligated by law to act only in the best interest of their principals.

Not all financial advisors are fiduciaries, which means many are not obligated to act in the absolute best interest of their clients. Only advisors who are registered with the Securities and Exchange Commission (SEC) or similar state securities regulators are fiduciaries. Those who are not bound by fiduciary duty are held only to a "suitability" standard. Rather than being required to recommend the most beneficial financial products, these financial advisors are free to recommend any products that are technically suitable, given their clients' goals and financial circumstances.

If your advisor works for a firm that offers mutual funds and is not a fiduciary, she may be directing you to invest in products for which she receives a commission, even if other products offered elsewhere might be better suited to your needs.

Though it may be tempting to simply hand over your investment account to a financial advisor and trust she will do what is best, it is important to have a basic understanding of the types of mutual funds she chooses and how they fit into your overall investment strategy. Communicate your goals to your advisor clearly, and read through any information she provides so you can retain control over your investment and ensure your advisor is working in your best interest.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.