Mutual Fund Classification
You take risks when you invest in any mutual fund. You may lose some or all of the money you invest (your principal) because the value of the financial assets (or securities) held by a fund goes up and down. Each kind of mutual fund has different risks and rewards. Generally, the higher the potential return (the money you can make), the higher the risk of loss. Before you invest, you must decide whether the goals and risks of any fund you are considering are a good fit for you.
The three main categories of mutual funds a Teenvestor should be concerned with are money market funds, bond funds, and stock funds. There are a variety of types within each category.
Money Market Funds
Money market funds have relatively low risks, compared with other mutual funds. They are limited by law to certain high-quality, short-term investments. Money market funds try to keep their value (NAV) at a stable $1.00 per share, but NAV may fall below $1.00 if their investments perform poorly. Investor losses on money market funds have been rare, but they are possible.
Bond funds (also called fixed income funds) have higher risks than money market funds, but seek to pay higher returns. Unlike money market funds, bond funds are not restricted to high-quality or short-term investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards.
Most bond funds have credit risk, which is the risk that compa-nies or other issuers whose bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds). Some funds have little credit risk, such as those that invest in gov-ernment bonds. But be careful: nearly all bond funds have interest-rate risk, which means that the value of the bonds they hold will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in government bonds.
Long-term bond funds invest in bonds with longer maturities (length of time until the final payout). The values (NAVs) of long-term bond funds can go up or down more rapidly than those of short-term bond funds.
Stock funds (also called equity funds) generally involve more risk than money market or bond funds, but they also can offer the highest returns (or the highest profit). A stock fund’s value (NAV) can rise and fall quickly over the short term, but historically stocks have performed better over the long term than other types of investments.
Not all stock funds are the same. For example, growth funds focus on stocks that may not pay a regular dividend but have the poten-tial to increase in value. Others specialize in a particular industry segment such as technology stocks. Stock funds are more appropriate for Teenvestors than bond funds.