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 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 of $5 billion or more, which means that the companies have outstanding stock worth at least $5 billion. These are well-known companies such as IBM, Ford, and General Electric.

Medium-Capitalization Funds
Midcap funds hold stocks of companies with market capitalizations between $1.5 and $5 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 of $1.5 billion or less. These are typically new companies. Many will fail, but some will grow exponentially. Historically, the greatest growth has come from this type of fund. 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." They also tend to be stocks that have a high dividend yield, and may therefore supply income as well as capital gains. Large value funds are particularly suited to conservative investors.

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.

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.) These funds are good choices for those who would rather trust the market than a fund manager. 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.

Growth and Income Funds
Growth and income funds divide their energies more or less equally between income stocks that pay high dividends and growth stocks that are expected to appreciate. They may include large or midcap value, growth, or blend stocks.

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.