Simply put, stock funds (also sometimes called “equity funds”) are mutual funds that invest only in stocks. For that reason, they are considered to be riskier than most other types of funds, such as bond funds or money market funds. Along with the greater risk, however, comes the potential for greater returns. Over long periods of time, equities have historically outperformed both bonds and cash investments, and when stocks do well, stock mutual funds naturally follow suit.
But not all stock funds are alike — these funds can vary greatly according to their stated objectives, their style of management, and the types of companies in which they invest.
Growth funds are stock funds that invest in stocks with the potential for long-term capital appreciation. They focus on companies that are experiencing significant earnings or revenue growth, rather than companies that pay out dividends. The hope is that these rapidly growing companies will continue to increase in value, thereby allowing the fund to reap the benefits of large capital gains. In general, growth funds are more volatile than other types of funds — in bull markets, they tend to rise more than other funds but in bear markets, they can fall much lower.
Value funds invest in companies that are thought to be good bargains — that is to say, they invest in companies that have low P/E ratios. These are the stocks that have fallen out of favor with mainstream investors for one reason or another, either due to changing investor preferences, a poor quarterly earnings report, or hard times in a particular industry. Value stocks are often the stock of mature companies that have stopped growing and that use their earnings to pay dividends. Thus value funds produce current income (from the dividends) as well as long-term growth (from capital appreciation once the stocks become popular again). They tend to have more conservative and less volatile returns than growth funds.
Aggressive growth funds are similar to regular growth funds, only they are more extreme. Like growth funds, aggressive growth funds target stocks of companies that are experiencing very rapid earnings or revenue growth. But aggressive growth funds tend to trade more frequently and take many more risks than regular growth funds. An aggressive growth fund might, for example, buy initial public offerings (IPOs) of stock from small companies and then resell that stock very quickly in order to generate big profits. Some aggressive growth funds may even invest in derivatives, such as options, in order to increase their gains. You should note that these funds can be quite volatile and risky investments.
If you want to achieve both growth and value objectives, the mutual fund industry has a ready solution for you: blend funds (or “blended” funds). These funds invest in both value and growth stocks so that you can enjoy current income and long-term capital appreciation within the same fund. Since blend funds tend to vary considerably it is difficult to make generalizations about how risky they are in comparison to other types of mutual funds — most likely, they are somewhat riskier than value funds and somewhat less risky than growth funds.
Sector funds are stock funds that invest in a single sector of the market, such as the energy sector or the biotechnology sector. Sector funds are usually used by investors to achieve growth — in other words, you would choose sector funds that match the industries that you think are going to do well in the future. But sector funds can also be used for other purposes too — for example, to act as a hedge against other holdings in a portfolio. Some common sector funds include financial services funds, gold and precious metals funds, health care funds, and real estate funds, but mutual funds exist for just about every sector. To be considered a sector fund, a fund must invest at least 25% of its portfolio in one sector, although many sector funds invest all of their holdings in a single industry. In general, sector funds are more volatile and risky than mutual funds that invest their assets across a wide variety of industries.
Stock funds may also be classified according to the market capitalization of the companies in which they invest. The market capitalization, or “market cap”, of a company is simply the value of the company on the stock market — in other words, it is the number of outstanding shares of the company times the price of those shares. There are three main types of cap funds: large-cap, mid-cap, and small-cap. Although the dividing line isn’t precise, large-cap funds tend to invest in companies with market caps above $10 billion, mid-cap funds tend to invest in companies with market caps of $1 billion to $10 billion, and small-cap funds tend to invest in companies with market caps below $1 billion. Some mutual funds also add a fourth category called micro-cap funds to describe funds that invest in companies worth less than $250 million. In general, the smaller the average market cap of the fund’s holdings, the more volatile the return; micro-cap funds can be especially risky.
Focused funds are funds that hold large positions in a small number of stocks. While many mutual funds hold 100 positions or more, focused funds usually have 10 to 40 positions at any given time. They emphasize quality over quantity, and would rather hold just the stocks they have the most confidence in, rather than diversifying across a large number of holdings. In theory, this should enable them to more thoroughly research and track their holdings, although they lose the benefits of diversification and tend to be more volatile than other mutual funds.