Income funds often contain more bonds than stocks and seek to preserve the capital investment while paying dividend and interest income. The corpus of the fund will remain somewhat stable during market declines and increases. However, bond values can be interest-rate sensitive and inversely relate to changes in interest rates. For those who can tolerate more volatility, a balanced fund is slightly less conservative than an income fund. These funds, which also invest in stocks and bonds, provide income while seeking some growth of capital.
The investment risk associated with stock, or equity, funds varies from moderate to aggressive. For investors with a long time horizon, some investment in aggressive growth funds may be suitable. The value of a growth fund will swing dramatically with changes in the market. Income is not a priority, and these funds are not apt even for younger investors who have a low tolerance for risk.
There are also funds that invest in narrow sectors of the economy as well as funds that invest in securities of other countries. Examples of sector funds include those that invest solely in healthcare, utilities and precious metals. These funds are obviously not diversified and are subject to risks associated with the sector. When investing in international stocks, an investor is exposed not only to market and political risk but also to exchange-rate risk. Nonetheless, depending on one’s individual situation, a percentage holding in sector and international stock funds may be advantageous.A novice investor should also be aware of the tax ramifications of investing in mutual funds that are not contained in a tax-favored, retirement account. If the fund manager frequently sells securities, the turnover ratio will be higher than that of funds holding securities for longer periods. Whenever securities are sold, an investor will realize capital gains and losses. Capital gains have historically been taxed at a preferred rate, and taxpayers may deduct up to $3,000 per year of capital losses. Any remaining loss may be deducted in future years. Dividend and interest income are also taxable. One way to avoid state tax is to purchase shares of municipal bond funds. Income from these funds may also be exempt from federal taxation.
A fund’s prospectus provides information about investment objectives and security holdings. Always read the prospectus when evaluating a fund. Pay attention to the turnover and expense ratios as well as the risk and nature of the holdings.