What Are Growth Stock Mutual Funds?

Definition, Example, and Strategy for Growth Mutual Stock Funds

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Growth stock mutual funds primarily invest in growth stocks, which are stocks of companies that are expected to grow at a rate faster in relation to the overall stock market. But how do growth stock mutual funds work and who should invest in them? Growth stock funds can be purchased through most mutual fund companies and online brokers.

Most investors are looking to grow their assets over time and growth stock mutual funds are an excellent tool to achieve this investment objective.

Definition and Example of Growth Stocks

Growth stock mutual funds buy and hold growth stocks. Technology stocks are good examples of what stock mutual fund managers buy for their portfolios. When Facebook (FB) stock was first offered to the public in 2012 it's valuation was at approximately $100 billion. The year prior (2011) it earned roughly $1 billion.

A simplified valuation represents "present value of future cash flows." In translation, if Facebook maintained its $1 billion annual income, it would take 100 years for an investor to earn back what they had invested. However, as incredible as this growth rate seems, Facebook tripled its price over the next three years, through 2015. By 2017, FB was among the largest growth stocks on the market and by 2018, the standout growth stock had averaged over 50% annualized return for the past five years.

A growth stock investor today is betting that a companies like Facebook will grow at a much faster rate than most other companies. In the example of FB stock, although the price fluctuated over its first three years of history, growth investors, growth stock mutual funds, and technology sector funds investing in Facebook enjoyed healthy returns.

Facebook is an extreme example but growth stock mutual fund managers are buying stocks of companies that have great "potential" for future earnings above and beyond the overall market, even though their price valuations seem "expensive" compared to the rest of the market. And this growth expectation can be higher than current price and earnings suggest.

Growth Stock Mutual Funds Investing Strategy

As the name implies, growth stock mutual funds typically perform best in the mature stages of a market cycle when the economy is growing at a healthy rate. The growth strategy reflects what corporations, consumers and investors are all doing simultaneously in healthy economies--gaining increasingly higher expectations of future growth and spending more money to do it.

Again, technology companies are good examples here. They are typically valued high but can continue to grow beyond those valuations when the environment is right. Another example of growth stocks is consumer discretionary stocks. Also called consumer cyclical stocks, these stocks invest in companies that manufacture or provide products or services that are not "necessary." These products and services include luxury items, hotels, and entertainment.

Investors should keep in mind that growth stocks can have temporary periods of extreme fluctuation and that growth stock mutual funds are best for aggressive investors with long-term investment time horizons, such as 10 years or more. Even though growth funds can have high returns in any given year, they also tend to decline more than the average stock fund during bear markets.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.