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
Mid-Cap
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). There are many others that may not be common household names.
Small-Cap
Small-cap stock funds invest in stocks of corporations of lower 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 rates 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 prices lower than the market value. Value stock funds may also be called “dividend mutual funds,” because they 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. It 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.
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
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. Be advised that short-term bond funds have lower average returns over time than bond funds with longer terms.
Intermediate-Term
Intermediate-term bond funds invest mainly in bonds that mature after four to 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.
Long-Term
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 than those with shorter terms and will likely cause negative returns if you invest in long-term bonds.)
