What Mutual Funds Invest in

Last updated: April 13, 2016

3 Common Types

1. Money-Market Funds

A money market mutual fund invests in high-quality debt, such as Treasury Bills, and compared to other debt investments, has a relatively short maturity (less than 1 year).  

While other types of mutual funds are priced at net asset value daily, money market fund shares are always priced at $1.00.

You can usually count on a money market fund to earn more interest than your bank savings account, but long-term the interest won’t be quite as high as a bond fund would earn. They are more liquid than a bond fund however, and some types of money market funds are tax-exempt.

Money market funds should not be confused with money market accounts (which are issued by a bank and are insured against loss by the FDIC). Money market funds are an investment, and as such, carry some risk of financial loss. However, the risk for these funds is considered to be “low”. Because the risk of loss is low, so are the potential rewards: Money market funds usually pay low interest rates (in recent years, many paid less than 2%).

Because of the low interest earnings, people generally find that money market mutual funds are better used for safe-keeping of savings than for growth of savings.

2. Stock Funds

Investing in a stock mutual fund gives you partial ownership of hundreds or even thousands of companies at once. When the companies post earnings, the stock fund and you as an owner reap a portion of the earnings and may also benefit from gains in the market value of the profitable companies’ stocks.  However, when the companies post losses, you and the fund also feel the pinch. Based on the number of funds and dollars invested in them, these are by far the most popular type of mutual fund.

A wide variety of businesses make their stock available for purchase by the public and investment companies (issuers of mutual funds). Financial experts analyze and sort all stock into categories and classifications to help investment advisers and investors make informed decisions when choosing stock. Here are a few of the most widely recognized categories and classifications of stock:

Large-company (Large Cap) U.S. Stocks

This class of stock is made up of the largest corporations in America. These companies’ brands are usually household names. Large company stock is often the mainstay of an investment portfolio.  Large cap companies have market capitalizations of $10 billion and above. “Market capitalization” is the total value of a public company's tradable shares and equals the market price per share times the number of outstanding shares.

Small-Company (Small Cap) U.S. Stocks

Although this class of stock is made up of smaller companies, keep in mind that the term “small” is relative. Small market capitalization (small cap) companies have market capitalizations up to $2 billion. Small cap stock is often more volatile than large company stock. As a whole, small cap company stocks have demonstrated slightly more returns than large cap stocks over time.

Foreign Company Stocks

These funds can invest in a variety of overseas companies or in companies based in a single region. For example, they may invest in Asia or Latin America companies.

  • They may invest in stocks of large foreign firms or small foreign firms or just in companies based in so-called emerging markets (such as China and India).
  • Some of these funds invest only in stocks of issuers in a single country.

Global Stock Funds

These funds can own both U.S. and foreign company stocks.  

Sector Funds

These funds invest in narrow slices of markets. For example,

  • Some funds invest just in healthcare stocks, energy stocks, or real estate.
  • Others may concentrate on stocks of in commodities companies, such as gold, silver, timber, or natural gas companies.

3. Bond Funds

While stocks represent an ownership share of a company, a bond is the equivalent of a loan to a business. When you buy a bond fund, the businesses borrowing money (the issuers) promise to pay back the loan principal with interest at a specified rate. Visit our page on Bonds to learn more. 

Bond funds are available in many different flavors. Maturity periods range from 1 month to 30 years. Some funds invest in a single market sector while other funds invest in multiple or even all bond markets. Bonds are also sorted into different categories and classifications. Here are some of the most common categories and classifications of bonds that mutual funds may invest in:  

A)   US Government Bonds

These bonds are considered to be the safest and most dependable bonds available. This also means that the interest returned on these loans is fairly low (3% or less).  

B)   Corporate Bonds

Companies, both foreign and domestic, often borrow money by issuing bonds. Corporate bonds, issued by both foreign and domestic issuers, generally have at least a 1-year maturity period.  

One key to picking a corporate bond fund is to consider the credit quality of the issuers of bonds held in the fund. Credit rating agencies have divided corporate bonds into two broad categories:         

   1) Investment Grade Bonds

  • The risk of default with investment grade bonds is relatively low.
  • These bonds typically offer lower yields than higher-risk bonds.
  • The top-rated (safest) bonds are rated AAA, AA, or A.          

        2)  High-Yield Bonds

  • These are commonly referred to as “junk bonds” because companies with low credit ratings issue them. In comparison to investment-grade bond issuers, there is a greater chance that high-yield bond issuers may default on their obligation to pay back investors. Because of the greater risk of default, interest yields offered by high-yield bonds are much higher---as much as six percentage points greater than investment-grade corporate bonds. Price volatility is also usually greater for high-yield bonds.  

C)   Municipal Bonds

Also known as “munis”, these bonds are issued by states, counties, cities and other governmental agencies, such as sewer and highway authorities. Here are some important things to know about municipal bonds:  

  • In most cases, interest from municipal bonds is exempt from federal income taxes.
  • Municipal bonds almost always pay less interest than taxable bonds of similar maturity and quality, but once you factor in the tax break you may be better off owning municipal debt, especially if you are in a high tax bracket.
  • Some funds invest only in bonds issued within a single state, so the income from those bonds will also be free of that state’s taxes for state residents.

*The information on this page is credited to IPT and Kiplinger. Their original materials are made available on the Kansas Securities Commissioner's website.