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Introduction

Stock (or "Equity") funds are mutual funds whose assets consist of shares of stock (ownership) in other companies. In other words, the mutual fund company gathers the funds from individual investors, pools these funds, then makes purchases of shares in many different publicly held corporations. So, with a relatively small investment, an investor is getting indirectly the potential benefit of owning shares of stock in many different companies. This diversification that mutual funds provide is one of the attractive features for many investors. Many investors also prefer to leave the choice of what company's shares should be purchased to a professional money manager.

Equity mutual funds are often categorized by the size of the companies they hold (the total value of their underlying stock) or by the style, or philosophy, of investing. The following sections will give an introduction into these fund classifications.

Funds Classified by Company Size

Large-Capitalization Funds
Large-cap funds hold stocks from companies with market capitalizations generally of $10 billion or more, which means that the companies have outstanding stock worth at least $10 billion. These are well-known companies such as IBM, Ford, and General Electric. Typically, large-cap funds offer generally consistent market fluctuation, however even for large-cap funds, the potential for high volatility still exists.

Medium-Capitalization Funds
Midcap funds hold stocks of companies with market capitalizations generally between $2 and $10 billion. As you might guess from the name, they are more volatile than large-cap funds, but less volatile than small caps.

Small-Capitalization Funds
Small-cap funds hold stocks of companies with a market capitalization generally of $2 billion or less. These are typically new companies. Many will fail, but some will grow exponentially. However, with greater growth comes greater volatility. Past performance is no guarantee of future results.

Funds Classified by Investing Style

Value Funds
Value funds hold the stock of companies that are believed to be undervalued in price. Think of them as "bargains." Large value funds are particularly suited to conservative investors. Potential risks of value funds include that a fund that was perceived as undervalued was in truth priced correctly at the time of purchase or that the fund doesn't increase in value over time as expected.

Growth Funds
Growth funds hold the stock of companies whose earnings are expected to increase faster than the rest of the market. These stocks will typically not pay much in dividends; instead, earnings are plowed back into the company. The objective for investors is long-term capital gains.

Blend Funds
Blend funds hold both growth and value stocks. If you are just beginning to invest in stock funds, this may be a good place to start. Blend funds combine the risks of both value and growth funds, but these may be somewhat mitigated by having the right balance of growth and value funds.

Index Funds
Index funds buy stocks to match certain market indices, like the S&P 500 (the 500 largest U.S. stocks) or the Wilshire 5000 (includes smaller stocks). They will attempt to track the index they follow. (One difference will be the costs of operating the fund, which should be less than the costs associated with actively managed funds.) The risk of index funds is that they take on the risk of the index they match, so if it loses percentage points, the fund's value drops as well. It's important to understand the index the fund is mirroring and consider how it fits your portfolio and financial goals. For an in-depth discussion of index funds, see the section Mutual Fund Management and Costs.

IMPORTANT NOTE: The S&P 500 index and Wilshire 5000 index are unmanaged indices widely regarded as indicators of domestic stock performance. The S&P 500 index and Wilshire 5000 index cannot be purchased directly by investors, and cannot depict or predict the performance of any investment. However, you may purchase an index mutual fund or Exchange Traded Fund (ETF) to closely mirror index returns.

Equity-Income Funds
Equity-income funds focus on stocks with dividends that are larger than average. These will be from large, established companies, especially utilities. They may include large or midcap value or blend stocks. Equity income funds may be more volatile than bonds or dividend-paying stocks, but they also may be less expensive to invest in. They are not considered well suited for short-term investors, but may pose less risk for those with time to ride out market losses.

Growth and Income Funds
Growth and income funds combine long-term appreciation with short-term income generated by dividends or interest payments. These funds often include a combination of stocks, bonds, and securities. Growth and income funds pose moderate risks, and they are popular with balanced investors.

International or Foreign Funds
International or foreign funds invest mostly in foreign securities. They carry an additional kind of risk because not only can the stocks go up or down, but the currency of the countries can also move in relation to the dollar. In addition, there may be risk due to political, social, or economic developments within the countries.

Global or World Funds
Global or world funds contain both foreign and U.S. securities.

Specialty or Sector Funds
Specialty or sector funds concentrate in a particular area. There are funds concentrating on biotech stocks, on health care stocks, on gold stocks, on real estate, or on utilities. Because they aren't diversified, these funds carry higher risk.

What Kind of Fund Should You Buy?
In a word, once again, diversify. While every individual situation will dictate investment selection, most investors should consider owning several different kinds of stock funds. You might want to start off with a large blend fund. This will give you some diversity of investing style. Then, you might add a small growth fund for capital gains over time. The next step might be an international fund. The U.S. is no longer the only major financial market, and when the stock market here tumbles, international funds may help minimize your overall portfolio loss. As you get more money to invest, look at midcap funds, and consider splitting your large blend fund into large growth and large value funds.