Question

a. Define four different classes of mutual funds? Discuss the characteristics and risks of each of the four classes you defined.

b. Discuss the different ways an investor can realize a return on a mutual fund investment.

Answer 1

There are four broad types of mutual funds: Equity (stocks), fixed-income (bonds), money market funds (short-term debt), or both stocks and bonds (balanced or hybrid funds).

Equity funds

Equity mutual funds buy stocks of a collection of publicly traded companies. Most mutual funds on the market (55%) are some type of equity fund, according to the Investment Company Institute. Equity funds have a higher potential for growth but more potential volatility in value. The younger you are, the more your portfolio should include equity funds, financial planners advise, as you have more time to weather inevitable ups and downs in market

Bond funds

Bond funds are the most common type of fixed-income mutual funds, where (as the name suggests) investors are paid a fixed amount back on their initial investment. Bond funds are the second most popular mutual fund type, accounting for about one of every five funds on the market, according to the ICI.

Rather than buy stocks, bond funds invest in government and corporate debt. Considered a safer investment than stocks, bond funds have less potential for growth than equity funds.

Money market funds

Money market mutual funds are fixed-income mutual funds that invest in high-quality, short-term debt from governments, banks or corporations. Examples of assets held by these funds include U.S. Treasurys, certificates of deposit and commercial paper. They are considered one of the safest investments and make up 15% of the mutual fund market, according to the ICI.

Balanced funds

Also known as asset allocation funds, these investments are a combination of equity and fixed-income funds with a fixed ratio of investments such as 60% stocks and 40% bonds. The best-known variety of these funds are target-date funds, which automatically reallocate the ratio of investments from equities to bonds the closer you get to retirement.

B)

With so many different types of mutual funds available in the market, picking one that suits specific investment needs the most is not an easy task. The simplest advice that can be given in that regard is to first understand your own needs. The next step would be to figure out what your goal is? Is it to build wealth quickly, at a moderate pace or at a slow pace. Once that is decided the last main thing to consider is the risk you are willing to take. The highest returns are general observed to come from the funds offering the highest risks. So if you want returns quickly and are willing to take risks than that is the fund to go for. If your objective is to build wealth slowly then going in for a medium or low risk mutual fund is ideal.

Since mutual funds always come with a factor of risk associated with them, no matter how small, it is imperative that investors read their policy documents carefully before investing. It would also be a good idea to read the document to ensure that they, the investors, have understood exactly what they have invested in and all the facilities that are available to them with that investment