Investors can select from over 8,000 mutual funds, according to the Investment Company Institute, as of April, 20021. In the case of your retirement savings plan, you've probably got a more manageable number of mutual funds from which to choose.
Most mutual funds can be categorized into one of three basic groups, or asset classes - money market, bond, and stock. In financial lingo, these are often called cash or stable value, fixed-income, and equity funds. Those that don't fit neatly into one of these three categories are called "hybrid" funds. They typically contain a mixture of securities from different asset classes.
Keep in mind that there are risks associated with every type of investment. The amount of risk varies for each investment. Investment risk and inflation risk aren't either/or things. Most investments generally involve more of one risk and less of the other.
Here's some fundamental information about each asset type.
Money market instruments are short-term IOUs issued by governments, corporations, banks, and other financial institutions. Certificates of deposit (CDs) and U.S. Treasury bills are both considered cash or money market investments. These types of investments are subject to "inflation risk" - the possibility that your investments will not earn enough to keep pace with inflation.
Bonds are IOUs issued by corporations or governments. When an investor purchases a bond, the bond issuer agrees to repay the money at a specified date in the future, while making interest payments for a specified time period. Usually, the amount of interest paid, or the "coupon," is a fixed percentage, which is why bonds are sometimes called "fixed income" investments. Bonds are sensitive to fluctuations in interest rates. If interest rates go up, bond prices tend to fall, and vice versa.
Bonds are subject to several types of risk.
- Inflation risk - the possibility that the investment will not earn enough to keep pace with inflation
- Default risk - the possibility that the bond issuer might not repay the money
- Investment risk - the possibility that the value of the investment will go down
Stocks, or equity securities, represent part ownership, or equity, in corporations. Each portion of ownership is called a share. Stocks are subject to investment risk - the possibility that the value of the investment will go down.
While your company's retirement savings plan has narrowed down your fund choices, you'll probably find that there are a number of different funds within each asset class. And, while it doesn't make choosing funds any easier, there are also other types, like international value funds, that cover more than one category. The table below gives brief explanations of the various sub-classes and investment styles. More information about specific mutual funds is also available under the Accounts tab at the top of this page, including quotes, historical performance, the prospectus, and more.
| Equity funds | Growth funds | Seek to increase the value of your investment over the long term, often investing in stocks of companies believed to have strong growth potential. Those that invest in the smallest, riskiest stocks are often called aggressive growth funds. Growth funds are more volatile than Money Market or bond funds. |
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| Growth & income funds | Generally purchase stocks of dividend-paying companies. They seek not only growth, but also income, which is generated by stock dividends, or a portion of a company's earnings. |
| Value funds | Invest in what are perceived to be "underdogs," or stocks of companies that the manager believes are undervalued in the marketplace and have the potential for future growth. |
| International funds | Invest in companies outside of the United States. Those that invest both inside and outside of the United States are called global funds. |
| Index funds | Purchase several of the same securities found in a particular index, like the Standard & Poor's 500® Index, in order to try to match its performance. |
| Sector funds | Invest in stocks of a particular sector of the market, such as technology or health care companies. |
| Fixed-income funds | Government bond funds | Invest in bonds issued by the U.S. Treasury or agencies of the U.S. government. |
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| Corporate bond funds | Purchase bonds issued by corporations. Bonds can be short-term, intermediate-term, or long-term. The longer the term, or maturity, of a bond, the more exposure it has to interest rate fluctuations, increasing its risk, as well as risk of default. |
| Global bond funds | Purchase bonds of corporations or governments from around the world. |
| *Federal municipal bond funds | Purchase bonds issued by the federal government. The interest is exempt from federal (and sometimes state and local) taxes. |
| *State municipal bond funds | Purchase bonds issued by a state government. The interest is exempt from most state taxes. |
| Hybrid funds | Asset allocation funds | Choose a mixture of investments, usually from different asset classes, to achieve a particular strategy, such as long-term growth. |
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| Fund of funds | Invest in a mixture of other mutual funds to achieve a particular objective. |
| Balanced funds | Invest in a combination of stocks and bonds to "balance" the risk of investing in either one type. |
| Money market funds | Taxable money market funds | Invest in short-term debt instruments, such as U.S. Treasury bills. Interest rates change daily, but the share price generally stays at $1. |
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| *Federal municipal money market funds | Invest in short-term debt instruments of the federal government. The interest is exempt from federal (and sometimes state and local) taxes. |
| *State municipal money market funds | Invest in short-term debt instruments of state governments. The interest is exempt from state taxes. |
Choosing mutual funds from the same asset class
Should you find that your plan offers three stock funds, for instance, you can differentiate them in several ways. First, determine what the fund invests in. Is it stocks of small companies, or large, established companies? Does it favor value stocks, or does it focus mainly on well-known and established companies? Does the mutual fund invest only in stocks, or can it invest in bonds if the manager deems it necessary? Can the mutual fund invest in companies outside of the United States, or is the manager limited to domestic stocks? You can usually answer all of these questions online by visiting a mutual fund company's Web site and reviewing the description of its mutual funds. Check the Accounts tab at the top of this page for information about the mutual funds available through your plan.
You'll usually find that the mutual funds in your plan have different characteristics. This can be a great advantage to you, offering you the chance to create a diverse portfolio of mutual funds from different asset classes.
Cheryl Marconi is a Massachusetts-based financial writer and editorial consultant. She has worked in the publishing and financial services industries for the past twelve years.
Would you like to know more about mutual funds? If your 401(k) plan account is serviced by Fidelity, you can access "The Mutual Fund - It's No Mystery," a six-part series covering the basics. Find it by logging into Fidelity NetBenefitsSM and clicking on the Planning tab.
