What are the different types of mutual funds?
In broad terms, there are five types of mutual funds. They are:
The major difference between each fund is determined by what they help invest your money in. To fully understand the different types of mutual funds, you need to have a solid understanding of what a mutual fund is.
What is a mutual fund?
Investment proposals usually come with heavy demands that can go as high as billions of dollars. As expected, not everyone has a thousand dollars sitting around not to talk of a billion dollars. With such high demands, almost everyone on earth is locked of investing; assuming mutual funds did not exist.
With a mutual fund, huge investments are broken into bits. Hence, many people can now come together and pool funds that match the huge demand. People who manage these aggregations of funds, and go on to select where to invest are known as fund managers.
Whatever a fund manager chooses to invest the pool of cash in is what determines the fund type. Based on this, let’s go on to break down the common types of mutual funds; starting with equity funds.
What are equity funds?
A little refresher, equity is the same thing as stock/company shares. In essence, an equity fund is one that invests your money in the purchase of stocks from various companies. Stocks added to the list are carefully selected by professionals who have access to quality information. In summary, returns for this type of fund are engineered by how the stocks of the underlying firms perform.
>>Learn More: How to invest with equity funds
Advantages of equity funds
- The fund is managed by professionals.
- They expose you to a lesser risk of investing in stocks yourself.
- Diversification of investments as fund managers have enough to spread across various stocks.
- Investing with equity mutual funds is more convenient than picking stocks yourself.
- Lower entry cost. To diversify your investments like a professional, you’ll need heavy cash.
Disadvantages of equity funds
- Despite the lowered risk, they’re still risky because the underlying instrument (stocks) is volatile.
- You have no control over the stocks your fund manager chooses.
- They are not great for short-term investment plans.
What are Bond funds?
These are mutual funds that pool your money, with those of others, in a basket of bonds. Bonds are a type of fixed income instruments. On fixed-income, these are instruments that pay investors a fixed rate over a certain period of time. Examples of these are locally issued government bonds and Eurobonds. Also, firms can issue bonds. In such cases, the fixed income instrument is known as a corporate bond.
Despite the fact that the rates are fixed, as these instruments are sold from one person to another the rates and prices change. To keep things short here, we wrote a detailed explainer for you here. It breaks down why these changes happen and how they relate to the fixed rate. But in the end, bond funds invest in bond instruments to earn you returns.
Further, there are a couple of variants. We have halal bond funds, Naira bond funds, and dollar bond funds. All of which are available on Cowrywise here.
>>Learn More: How to invest with bond funds
Advantages of bond funds
From the ease of access to returns payout, these funds have peculiar advantages. Here they are:
- They are less risky when compared to equity funds. That is they moderately risky in nature.
- They offer higher returns than money market funds.
- Investing in bond funds takes off the stress that comes with investing directly in bonds.
- They usually pay out returns more frequently than regular bonds.
Disadvantages of bond funds
There are always two sides to a coin. So, showing you the good without the not-so-good wouldn’t match our commitment to transparency. Here are some drawbacks with bond funds:
- When compared to equity funds, they have higher management fees.
- Bond funds are made up of different bonds. They have varying maturity dates and their rates change. So, you have no clear view of how much you’ll earn exactly till payout dates.
- Individual bonds are more stable than bond funds. This is still due to the fact that a bond fund has multiple bonds that mature differently at different rates.
Money Market Funds
This is the favourite option for beginner investors. They allow anybody access to the secure and low-risk world of market instruments. That is, money market funds invest a pool of cash, from various investors, in the money market. These instruments, which include treasury bills, have short maturity dates. Since they’re low risk their returns are usually lower in comparison to other types of funds.
Advantages of money market funds
- All mutual funds are secure and duly regulated, but these are the safest in terms of risk.
- They’re great for emergency funds.
Disadvantages of money market funds
- They offer lower returns compared to other types of mutual funds.
- They are not always great for hedging against inflation.
>>Learn More: How to invest with money market funds
What are Balanced Funds?
As the name suggests, these are mutual funds that bring together various instruments. For example, a fund can invest 40% of your money in equities/stock and 60% in government bonds. What these funds try to do is reduce your investment risk by diversification.
Advantages of balanced funds
- Improved diversification; which helps with lowering risk.
- A good starter for those who plan to invest in equity funds later.
- Stabler returns when compared to equity funds
Disadvantages of balanced funds
- Though some invest partly in equities, their returns are usually lower than those of equity funds.
- You have no control on how allocation across different asset classes is done.
What are Halal Funds?
These are funds that invest in halal-approved investments; from bonds to equities. As long as they match halal standards, such funds can invest in them. In most cases, they invest in (Sukuk) bonds, halal equities or mix both. There are also other forms of halal investments they push funds to.
Halal refers to anything categorized as okay for a Muslim to participate in. Hence, a halal investment is one that anyone–including a Muslim–can invest with.
Advantages of halal funds
- Transparent screening of investments your money goes.
- Lower management costs.
- Moderate-risk investment due to screening process.
Disadvantages of halal funds
- Limited options for investing due to the screening process.
- Lesser diversification. These concentrate the risk of investments in a limited number of options.
>>Learn More: How to invest with halal funds
What else would you love to know about mutual funds? Drop a comment and we’ll advise you on what to read next.