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Types of Mutual Funds... Page 2
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Fixed-Income Funds
- Money Market Funds. Consist of short-term corporate debt or money
market instruments backed by the U.S. Government (such as Treasury bills). Government debt
normally has a lower yield because of this guarantee. Money Market funds offer low
risk and stability of principal -- in exchange for a lower rate of return. Best suited for
conservative investors who depend on investment income, desire capital preservation, or
want immediate liquidity. Many come with free check-writing privileges.
Municipal-Bond Funds. Consist of
bonds issued by a single state or group of states. Muni funds are exempt from federal
taxes and, if you're a resident of the state where the bond was issued, you may be exempt
from state taxes as well. There are different types of muni funds to choose from:
high-yield (low grade), single-state, high-grade, intermediate-term (conservative),
short-term, and long-term. Municipal bond funds are ideal for investors who are in high
federal and state tax brackets.
Short-term Bond Funds. Consist of
short-term corporate or government bonds that mature in 3 years or less. These bonds are
the least sensitive to interest rate changes and provide the most stability among bond
funds -- in exchange for one of the lowest rates (beating money market funds by a small
margin). Short-term bond funds are ideal for investors who are planning a major purchase
within a few years (car, home, etc.).
Long-term Bond Funds. Consist of
long-term corporate or government bonds that mature in 10 years or more. These bonds are
the most sensitive to interest rate changes and provide the least stability among bond
funds -- in exchange for a higher rate. Long-term bond prices tend to move more
dramatically with interest rates changes. These funds are ideal for investors who plan on
holding the bonds until maturity and are willing to accept some volatility in exchange for
maximum income.
GNMA Funds. Consist of mortgage
backed securities that are issued by the Government National Mortgage Association -- or
GNMA. These funds do incur some risks. When interest rates decline, homeowners usually
refinance at the lower rates -- essentially prepaying their old mortgages. Proceeds from
the payoffs have to be reinvested at the lower rates. This results in a lower yield for
GNMA investors. GNMA funds are ideal for investors seeking current income and for those
who understand the inherent risks (lower returns) associated with interest rate
fluctuations.
High-grade Corporate Bond Funds. Consist
of high-rated corporate bonds that are issued by well-established and financially strong
companies. Interest rates are normally lower since the risks are considerably less --
rates are comparable to government bond funds. Ideal for conservative investors who
require current income and are willing to accept lower rates in exchange for less
volatility.
High-yield Corporate Bond Funds.
Consist of corporate bonds, or "junk bonds", that are low-rated but pay a higher
interest rate than government bonds -- since there is a higher risk of default. Interest
rates depend on the issuer's financial condition (their ability to make payments). The
stronger the company, the lower the risk and the lower the interest rate. Ideal for
investors who require high current income and are willing to assume the high risk
associated with junk bonds.
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