There's more to mutual fund style than fashion. It is a basic description of how the fund invests. When distinguishing between the basic types of funds, the style of a mutual fund can refer to a few core traits. These are the stock investing objectives of value or growth, as well as the average market capitalization of the fund's portfolio holdings.
If you invest in mutual funds, you should be thinking about whether your fund is best formed to meet your goals and comfort with risk. There are quite a few factors that go into choosing the stocks in your fund, such as market capitalization, objective, credit quality, and maturity.
Stock Funds and Market Capitalization
Stock funds are first categorized by style in terms of the average market capitalization. The "market cap" is used to measure the size of a business, and is expressed as a figure of the single share price times the number of outstanding shares.
Large-cap stock funds invest in stocks of corporations with large market cap, most often higher than $10 billion. These companies are so large that chances are you have purchased goods or services from them in the past, if not often, or at the very least you will have heard of them. Some large-cap stock names include Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Facebook (FB), and Tesla (TSL).
Mid-cap stock funds invest in stocks of corporations of mid-size capitalization, most often between $2 billion and $10 billion. You may know many of these names, such as Skechers U.S.A. (SKX), Lending Tree (TREE), Semtech Corp. (STMC), Upwork (UPWK), and Dolby Labs (DLB). But there are many others that may not be common household names.
Small-cap stock funds invest in stocks of corporations of small-size capitalization, most often between $500 million and $2 billion. You may also hear smaller caps called "micro-cap" stocks.
The Investment Objectives of Stock Funds
Stock funds are next defined by their objective, of which there are three main types: growth, value, or blend.
- Growth stock funds: These invest in growth stocks, which are stocks of companies that are expected to grow at a rate faster than the market average.
- Value stock funds: These invest in value stocks, which are stocks that an investor or mutual fund manager predicts will be selling at a price lower than the market value. Value stock funds may also be called dividend mutual funds because value stocks often pay dividends to investors. Standard growth stocks, on the other hand, do not pay dividends but instead reinvest these funds to further grow the corporation.
- Blend stock funds: As the name implies, these funds invest in a blend of growth and value stocks.
Bond Fund Credit Quality
This broad categorization reflects how well the issuer will be able to repay the bond investors. You can think of credit quality as a company's or country's credit score. The score is expressed as a rating, which is given by a ratings agency, such as Standard & Poor's. They will assign a grade on a scale of 'AAA' for the highest, down to 'D' for default.
Low credit quality bonds are also called high yield or "junk" bonds because of their greater risk of default. They also come with higher yields to pay bond investors for the risk involved.
Bond Fund Maturity
Also called a bond's duration, a bond's maturity can be thought of as an amount of time, which loosely and simply translates to mean the number of years of the bond's term. A mutual fund can hold dozens or hundreds of bonds, and the total maturity is often expressed as the average duration of the bonds held in the mutual fund.
Short-term bond funds invest mainly in bonds that mature in less than four years. Within the category of short-term bond funds is the ultra short-term bond fund, which invests in bonds that mature in less than one year. If you tend to invest on the conservative side, you may like short-term bond funds because they have lower interest rate sensitivity. But be advised, short-term bond funds have lower average returns over time than bond funds with longer terms.
Intermediate-term bond funds invest mainly in bonds that mature between four and 10 years. These bond funds offer a balance of fair or reasonable returns for a fair amount of interest rate risk, which is why many investors like them. Since it is hard to predict economic conditions, you may opt to "ride the fence" of risk by putting your money into intermediate-term bond funds. If, for example, interest rates go up, bond prices will go down. The longer the term, the more bond prices will fluctuate. Short-term bond funds will perform better when interest rates are rising, but long-term bond funds will perform better when interest rates are falling. It follows that intermediate-term bond funds tend to find a steady middle ground.
As a rule of thumb, bond prices move in the opposite direction of interest rates.
Long-term bond funds invest mainly in bonds that mature in more than 10 years. Therefore these bond funds have greater interest rate risk. When interest rates are expected to fall, long-term bonds are your best bet for higher returns, as compared to short- and intermediate-term bond funds. The opposite is true in rising interest rate environments (long-term bond prices will fall faster compared to those with shorter terms and will likely cause negative returns if you invest in long-term bonds).