7 common types of mutual funds
1. Money market funds
These funds invest in short-term fixed income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with a lower potential return then other types of mutual funds. Canadian money market funds try to keep their net asset value (NAV) stable at $10 per security.
2. Fixed income funds
These funds buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns. High-yield corporate bond funds are generally riskier than funds that hold government and investment-grade bonds.
3. Equity funds
These funds invest in stocks. These funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You can choose from different types of equity funds including those that specialize in growth stocks (which don’t usually pay dividends), income funds (which hold stocks that pay large dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these.
4. Balanced funds
These funds invest in a mix of equities and fixed income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds. Aggressive funds hold more equities and fewer bonds, while conservative funds hold fewer equities relative to bonds.
5. Index funds
These funds aim to track the performance of a specific index such as the S&P/TSX Composite Index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.
Active vs passive management
Active management means that the portfolio manager buys and sells investments, attempting to outperform the return of the overall market or another identified benchmark. Passive management involves buying a portfolio of securities designed to track the performance of a benchmark index. The fund’s holdings are only adjusted if there is an adjustment in the components of the index.
6. Specialty funds
These funds focus on specialized mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund may invest in companies that support environmental stewardship, human rights and diversity, and may avoid companies involved in alcohol, tobacco, gambling, weapons and the military.
These funds invest in other funds. Similar to balanced funds, they try to make asset allocation and diversification easier for the investor. The MER for fund-of-funds tend to be higher than stand-alone mutual funds.
Before you invest, understand the fund’s investment goals and make sure you are comfortable with the level of risk. Even if two funds are of the same type, their risk and return characteristics may not be identical. Learn more about how mutual funds work. You may also want to speak with a financial advisor to help you decide which types of funds best meet your needs.
Diversify by investment style
Portfolio managers may have different investment philosophies or use different styles of investing to meet the investment objectives of a fund. Choosing funds with different investment styles allows you to diversify beyond the type of investment. It can be another way to reduce investment risk.
4 common approaches to investing
- Top-down approach – looks at the big economic picture, and then finds industries or countries that look like they are going to do well. Then invest in specific companies within the chosen industry or country.
- Bottom-up approach – focuses on selecting specific companies that are doing well, no matter what the prospects are for their industry or the economy.
- A combination of top-down and bottom-up approaches – A portfolio manager managing a global portfolio can decide which countries to favour based on a top-down analysis but build the portfolio of stocks within each country based on a bottom-up analysis.
- Technical analysis – attempts to forecast the direction of investment prices by studying past market data.
You can learn about a fund’s investment strategy by reading its Fund Facts and simplified prospectus.
Mutual fund companies often build relationships with advisors and encourage them to sell their funds. When you’re choosing an advisor, find out if they focus on the funds of a certain company or a specific family of fundsFamily of funds A group of different kinds of investment funds managed by the same company.+ read full definition.