Types of Mutual Funds

There are many different categories but only a few basic mutual fund types.

For the average investor, the many types of mutual funds that they learn about is a confusing alphabet soup that can be intimidating. But for effective mutual fund investing, it is essential to have a working knowledge of all the different types of mutual funds out there. Following is a list of almost every type of mutual fund that you are likely to encounter along with descriptions that are easy to understand.

The three basic types of funds are:

Open End Funds

These can issue an unlimited number of shares for sale and can buy and sell securities for its portfolio at any time, being actively managed by professional managers. The Net Asset Value (NAV) of the fund is derived from the closing value of all its holding at the end of the trading day. You can buy or sell shares of these funds daily at the close of each trading day. The term "mutual fund" usually means this type of fund. These funds can be further broken down to sub-types depending on how they are sold--Front End Load if they are sold with a commission required up front, Back End Load if they have a load when selling the fund and No Load when there is neither a front or back load.

Index Funds are usually open end and sold as no load funds. They are passively managed and aim to track the performance of a particular index by investing in the same investments that make up that index. So an S&P Index Fund will own all 500 underlying stocks in that index and nothing else.

Closed End Funds

This type is made up of a fixed number of shares which are normally only redeemable at liquidation. However, most funds of this type maintain a secondary market through broker-dealers where their shares can be bought or sold much like a stock throughout the trading day. They are not actively managed and usually hold a fixed portfolio of investments. Their prices are dependent on more than the cumulative value of these investments (NAV) however and market factors can cause them to fluctuate like stock prices. Their share prices therefore don't normally reflect their exact Net Asset Value and may trade at a premium or discount to the NAV. As with stocks, you pay an "ask" price to buy shares and receive a "bid" price to sell with the broker making his profit from the "spread" or difference.

Unit Investment Trusts

UITs, are technically not considered to be "mutual funds" although they are similar to closed end funds. They are not actively managed, they consist of a fixed portfolio of securities and have a specific maturity date.

Besides the above three basic types, a couple of newer fund types have become popular over the past few years:

Exchange Traded Fund

The ETF is a relatively new type of fund that is becoming very popular because of its flexibility and investment benefits. These hold a fixed portfolio of investments and trade at or close to their NAV throughout the trading day. Most of them have been created to track an index but unlike index funds, they trade like stocks.

Hedge Fund

This is another new type of investment fund that is very flexible in what it can invest in and are designed to hedge risk using a wide range of agressive investment techniques, including derivatives and trading, that are suitable only for very wealthy investors. Minimum required investment amounts for hedge funds are commonly $1 million.

Besides these basic types of mutual funds, we may come across many additional mutual fund categories that have to do mainly with open end mutual funds, the most common and popular type of fund, and they are classified according to what they are invested in and what their investment objectives are.