An index fund attempts to match the performance of an index, such as the Standard & Poor's 500 stock index. It does this by holding the same securities used by the index. It is not possible to invest directly in any index.
A sector fund generally focuses on a specific industry, such as biotechnology or real estate.
Some mutual funds have a combination of objectives.
For example, a balanced fund often invests in stocks and bonds, hoping to achieve both growth and some income.
An asset allocation, lifestyle, or lifecycle fund typically invests in all three of the major asset classes; the amount of each class depends on the fund's asset allocation strategy.
A fund using basic asset allocation devotes a set percentage of its assets to each type of investment. An example could be 50 percent to stocks, 30 percent to bonds, and 20 percent to cash. This allocation is generally held steady.
A lifestyle fund will determine its allocations based on your tolerance for risk; a conservative fund would likely focus on stability and/or income, while an aggressive fund typically pursues growth/capital appreciation.
A lifecycle fund tends to shift the allocation of its assets over time, often becoming more conservative as you get closer to your goal.
The Advantages of Mutual Funds
In addition to providing a diversified portfolio, mutual funds have other advantages:
Experienced money management: When you select an actively managed mutual fund, part of what you pay for is the fund manager's experience and expertise. This professional money manager looks at hundreds of securities and decides what to buy and when to sell.
Liquidity: By redeeming your shares, you can easily convert your mutual fund investment into cash.
The ability to make small investments cost-effectively: By investing through your workplace retirement plan, you're able to start your account with a very small investment, and add to it regularly. Making regular investments through your workplace savings plan means that you won't generally owe a transaction charge on each purchase (though workplace plans may include overall plan fees, and some funds may impose a charge if you sell your shares before a certain time period has passed).