Many mutual funds combine an investment objective with a specific category of stocks. For example, a fund might be an international fund whose objective is growth, or a growth fund that specializes in small-cap stocks. Here are some common stock fund types, based on their investment objectives:
A growth fund’s primary objective is capital appreciation over the medium- to long-term. Investors in growth funds often are willing to pay a high share price because they expect future earnings to be much higher. Growth companies often reinvest earnings in their businesses in order to continue to grow; therefore, they may pay only minimal dividends, if they pay dividends at all. The risk with growth investments is the possibility of overpaying for future growth that may never materialize. Investing in a growth mutual fund allows you to spread your investment over many different companies. A disappointing performance by one company may be offset by the better performance of another.
Aggressive growth fund
Often known as capital appreciation funds, aggressive growth funds tend to take greater risk in pursuit of potentially higher returns than ordinary growth funds. For example, an aggressive growth fund might buy initial public offerings of stock from a small start-up or innovative tech company and resell that stock quickly to generate immediate profits. Such companies do not normally pay dividends, and returns are derived almost exclusively from capital appreciation, or growth in share value.
Aggressive growth funds have the potential to turbo-charge a portfolio, especially when the market is going up. However, the companies in which they invest have a high failure rate and also are normally the ones hardest hit in bear markets. To invest, you need a relatively long time horizon and a high tolerance for volatile returns. Also, the rapid buying and selling of stocks can generate capital gains and losses that may impact your tax liability.
The primary objective of a value fund is long-term growth. Typically, these funds invest in companies that exhibit certain characteristics such as a stock price that’s low relative to the company’s assets, earnings, or cash flow; products or services that give the company a competitive edge; a quality balance sheet that demonstrates sound financials; high or increasing insider ownership; and strong, forward-thinking management.
Equity-income/Growth and income funds
Though they may seem like a hybrid category, both growth and income funds and equity-income funds are actually types of stock funds. An equity-income fund focuses primarily on income from equity (dividends from common, preferred, or convertible stock) rather than bonds. Equity-income fund tends to invest in stocks of companies that have a history of regular dividend payments.
A growth and income fund is likely to invest in stocks that pay substantial dividends but that also are considered growth companies. It may combine growth stocks with other stocks whose primary attraction is the dividends they pay. Because income is a key part of such funds’ objective and can help counteract the volatility of stock values, both categories are generally considered less aggressive than a growth fund.