Question

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

Answer 1

Answer:

Four different types of mutual funds are given below

· Stock Funds or Equity funds

· Bond Funds or Fixed-Income Funds

· Balanced Funds

· Money Market Funds

The characteristics and risks of each of the four above mentioned mutual funds are given below.

Stock Funds or Equity funds

As the name suggests equity funds or stock funds means these are the funds which normally invests in stocks or equities. Equities can be of small cap, large cap or mid-cap equities. These funds can be invested in domestic equities or in foreign equities

Characteristics of Equity Funds:

· The investment portfolio should be as per the name that means at least 60% of the portfolio should be invested in equity shares

· Asset allocation can be made purely in stocks of large-cap, mid-cap, or small-cap companies depending on the market conditions

· Portfolio allocation will be inline with the investment objective

Risk of Equity Funds:

· Volatility risk – Equity funds normally invests in stocks or share of different companies and normally share prices depend on the performance and market condition of the company. If performances became poor, then the stock price will go down and vice versa which impacts the investments as well.

· Currency risks – Equity funds can be invested in domestic as well as in foreign equity. If it’s invested in foreign equity and the exchange rates fluctuate then the investment also suffers.

Bond Funds or Fixed-Income Funds

As the name suggests bond funds or fixed-income funds means these are the funds which normally invests in bonds or fixed-income instruments which provides the fixed return. For example - government bonds, corporate bonds, or other debt instruments

Characteristics of Bond Funds:

· As the funds are invested in fixed-income funds so, it normally generates more income compared to other investments like certificates of deposit and money market investments

· Most of the bond funds are of lower risk because, a bond holder will receive the principal on the bond if the bond is held to maturity

· One of the biggest advantages to bond funds is the relative liquidity that means If an investor wants to sell part or all an investment, they can simply place a sell order with the broker, and it will be executed

Risk of Bond Funds:

· Interest risk – Interest rates are directly linked with bond fund. So, If the interest rate changes, the price of the debt instrument will also change. For example, if the rate of interest increases then, the price of bonds decreases, and the value of bonds also decreases.

· Inflation risks – Inflation risk is the risk that an increase in price level will determine the purchasing power of a bond’s fixed interest rate. Investors normally attracted to bond mutual funds due to the fixed interest earnings. But these earnings normally subject to inflation risk.

Money Market Funds

Money market funds means these are the funds which normally invests in risk-free short-term debt instruments that means mostly government Treasury bills.

Characteristics of Money market Funds:

· Money market mutual funds provide investors with higher liquidity because these funds are invested in securities that mature in short periods of time and can be liquidated for cash

· These funds invest in highly rated securities, money market funds which offer a high degree of safety

· Money market funds also offer investors higher yields than traditional savings accounts

Risk of money market Funds:

· Interest risk – This is the risk associated with fluctuating interest rates. Yields share an inverse relationship with interest rates, so when interest rates rise, yields become downgrade and vice versa.

· Inflation risks – This risk occurs when the cash flows from a money market fund down because of inflation. In other words, inflation cuts down how the money market fund performs

Balanced Funds

As the name suggests balanced funds means these are the funds which normally invests in different kind of investments to balance the return that means invests in hybrid of asset classes, whether stocks, bonds, money market instruments, or alternative investments.

Characteristics of Balanced Funds:

· Balanced funds usually invest in 60% equities, 40% debt

· Balanced funds investment goal is both income and capital appreciation of the investor

· Balanced funds provide the conservative investors appropriate growth that outpaces inflation and income to meet their current needs

Risk of Balanced Funds:

· Balanced fund controls the asset allocation and that might not always match with the optimal tax-planning movements

- This is a safe investment, but it reduces the returns