Mutual Funds: About Stock Funds

Stock Fund Basics (also called Equity Funds)

Stock funds invest only in stocks. They can follow any of a variety of goals and strategies. Stock funds generally are more risky than money market or bond funds, but they can offer the highest returns.

Historically, stocks have performed better over the long term than other types of investments. A stock fund’s value (NAV) can rise and fall quickly over the short term. Stock funds are a good choice, especially for younger investors with longer time horizons for investing.

Stock funds can be grouped by strategy and by size. More detail about each is below on this page.

Types of stock funds can be grouped by investment strategy:
  • Growth Funds
  • Value Funds
  • Blend Funds — also called Blended Funds
  • Sector Funds
  • Index funds
  • International Funds
Types of stock funds can be grouped by size of the companies they invest in:
  • Large Cap
  • Mid Cap
  • Small Cap

Growth Funds

Growth funds invest in stocks that are expected to be growing fast for potentially large capital gains. This is as opposed to stocks that pay a regular dividend. These are companies that are expected to have rapid growth in earnings or revenue. With rapid growth, investors are looking for big increases in the value of the company.

Growth funds are generally more volatile and risky than the other types of stock funds.

Aggressive growth funds invest even more aggressively than growth funds because they take on greater risk. They sometimes invest in IPOs (initial public offerings) and options. These funds are highly volatile and very risky.

Value Funds

Value funds invest in stocks that are thought to be undervalued or overlooked by the market. These stocks are thought to be “bargains” because they have low P/E ratios (price-to-earnings).

Value funds generally produce income from dividends. They also can offer capital appreciation if the stocks do well. Overall, value funds tend to be less risky than growth funds.

Real Story: When I was picking mutual funds for my 401(k) at my first job after getting my undergraduate degree, I was a sucker for value funds. I loved a bargain. Still do. I thought by buying a value fund, I was buying stocks that had simply fallen out of favor and were sure to bounce back. Sometimes that is true. (My simple strategy worked when I invested in health care stocks when they were out of favor.) However, it is not so simple.


A stock can be a “value” stock because of poor earnings, or because it is a mature company whose growth has stalled, or because of difficult times in an industry, or because of other reasons that will prevent the stock from simply bouncing back and making the investor lots of money.

My little story does not mean you should rule out value funds. Just buy more intelligently than I did when I was just starting out.

Blended Funds (also called Blend Funds)

Blended funds invest in both value and growth stocks. With a single mutual fund, you can get income as well as long-term capital appreciation. There are lots of different blended funds, so risk-reward varies alot. Overall, they tend to be more risky than value funds, but less risky than value funds.

Sector Funds

 Sector funds specialize in investing in stocks in a specific industry segment such as technology, gold, health care, energy, precious metals, biotechnology and many others. Because they invest in only one sector, this type of fund is generally more risky than the other types of funds that invest in a wide variety of industries.

Real Story: Do not let this comment about risk scare you off. This is one of my favorite types of mutual funds and why mutual funds can really shine. Here is why.  A sector fund is just a portion of a portfolio. Investing in the fund enables me to invest in a specific sector where it would be difficult to invest in individual stocks directly.

This can be because I cannot own enough different companies in that sector, or becuase I lack the expertise to pick investments in that sector. For example, a precious metals enables me to invest in many companies in a single fund. Biotechnology is an example of an area that I do not have the know-how to invest in individual companies.


International Funds

International Funds can be further broken down into these types:
  • Global Funds — invest in both U.S. and international stocks
  • Foreign Funds — invest mostly in non-U.S. stocks
  • Country Specific Funds — invest in only one country or region
  • Emerging Markets Funds — invest in small developing countries
As you get more narrow in focus in international funds, the risk tends to go up. Emerging market funds are very risky. However, like with sector funds, investing a small part of your portfolio in an emerging market fund is a cost effective, efficient way to invest in emerging markets that is impossible to invest in directly.

Index Funds

Index funds attempt to earn the same return as a particular market index by investing in all, or a sample, of the companies included in that index. The S&P 500 is just one such index. The Vanguard 500 fund is one of the best known funds that tracks the S&P 500. There are many indexes and many, many funds.

Overall, index funds have such low expenses, that they are worth a look. See Managed Funds vs. Index Funds below for more detail.

Large Cap, Mid Cap, Small Cap, Micro Cap Funds

These are funds classified according to the market capitalization (“market cap”) of the companies they invest in. Market cap is the number of shares outstanding times the price of those shares. This sets the value of the company on the stock market.

Large cap funds invest in the very biggest companies (market cap above $10 billion). These are well-established companies that tend to pay dividends.

Mid cap funds invest in medium sized companies (market cap between $1 billion and $10 billion).

Small cap funds invest in small companies (market caps below $1 billion). These corporations generally do not pay dividends. Instead, using their profits to grow.

In general, the smaller the companies, the more volatile the fund.

Managed Funds vs. Index Funds

 A managed mutual fund employs a manager who buys and sells the stocks in the fund. The fund manager actively researches and picks the investments he or she thinks will perform best. The fund is “actively managed.” Managed funds have higher costs than index funds. These costs eat into your investment returns.

An index mutual fund invests in the stocks that are listed in a particular index. Overall, the fund attempts to approximate, mimic, or represent, that index. For example, the S&P 500 is an index. An index fund does not employ a manager. The index defines what stocks to invest in. The fund is “passively managed.”

The performance of index fund does not exactly match the index it tracks. Some funds do a little better, some do worse. This is because the index fund still has some expenses, though they are lower than managed funds. Also, a fund has some flexibility in exactly how they buy and sell stocks to match the index.

An index fund has much lower costs than an actively managed fund. And, amazing, index funds on average perform better than most actively managed funds, even before factoring in loads. Over time, small differences in performance add up. However, if you invest in the wrong index, you are not going to make money.

There are lots of indexes beyond the S&P 500 mentioned above.

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