Comparing 4 Different Types of Mutual Funds

Equity mutual funds are also known as "stock funds."⁴ When you buy a share of an equity fund, it’s sort of like buying a small piece of each company’s stock inside the fund. If you’re interested in trading individual stocks, read “A Guide to Investing in Stocks.”

When you invest in equity mutual funds, you make money by selling your mutual fund shares at a higher price than you bought them. Equity mutual fund shares increase in value if the market price of the stocks inside the fund rises, or if they issue dividends (a tiny share of the company’s profits) that are reinvested in the fund. Typically, the fund manager selects stocks based on the fund’s stated investment goals and buys and sells to achieve those goals – goals which are commonly indicated by the name of the fund itself. A private equity fund, for example, invests in privately held companies not traded in the stock market.⁵

Bond funds are a type of mutual fund that invest in debt.⁴ Bond funds allow investors to indirectly lend money to private companies, governments, or other debt “instruments” in exchange for interest. The interest payments from the bonds are fixed – aka, always the same – and are used to pay regular dividends to the fund’s shareholders. Because of this, bond funds are sometimes called “Fixed Income” mutual funds,⁴ even though the dividends you receive may change over time as the fund buys and sells bonds. 

Some fund shareholders opt to grow their investment by automatically reinvesting their dividends into more shares of the bond mutual fund, while others choose to take it as income. You can also earn money from bond mutual funds when bond fund shares increase in value.

The two main reasons investors might choose to invest in bond funds instead of simply buying bonds outright are the ability to buy and sell regularly, and to diversify risk.

There are categories of bond mutual funds:³

• Treasury bond funds: These invest in either federal, state, or municipal bonds or bonds that are guaranteed by the U.S. government. Government bond funds typically have lower default risk and lower rate of return.
• Corporate bond funds: These mutual funds invest in bonds issued by private companies. Yields on corporate bonds, and the mutual funds that hold them, tend to be higher than government bonds, reflecting the increased risk of default. 

Like with equity mutual funds, there are global and international versions of government and corporate bond funds. You can use the 30-day yield to compare the income streams of different bond mutual funds. The 30-day yield is an industry-standard metric that helps investors project what a bond mutual fund’s interest might be for a full year, using a formula provided by the U.S. Securities and Exchange Commission.⁶

Money market mutual funds are fixed-income funds that invest in low-risk, short-term debt.⁴ They are not to be confused with money market bank accounts, which, despite the name, are a type of savings account that has nothing to do with the stock market.⁷ Since they’re short term and are limited to high-quality debt instruments, money market funds can help reduce uncertainty and therefore lower risk. But the trade-off for low risk is low returns. 

Money market mutual funds are classified by the U.S. Securities and Exchange Commission (SEC) into two categories based on the fund’s holdings:⁴

• Government money market funds invest primarily in cash, U.S. Treasury bonds, and other securities guaranteed by the U.S. government.

• Retail money market funds work by limiting all beneficial owners of the fund to natural persons.

Balanced funds are mutual funds that invest in both equities and bonds, usually according to a fixed ratio.⁴ In general, balanced funds are considered more conservative as the allocation percentage of equity holdings decreases and bond holdings increase. A version of balanced funds, called “Target-Date” funds, automatically reallocate their holdings by increasing their bond component as the target date gets closer.⁸ This type of mutual fund is often used for college savings and retirement accounts, which have natural target dates. 

Balanced funds can be a convenient way to diversify investment holdings, especially over time. They’re also lower risk, but they typically have higher fund expenses - so compare expense ratios when comparing balanced funds.