Mutual funds come with a variety of risk profiles – and potential rewards. Before investing, refer to the fund's simplified prospectus for a full description of its investment objectives.
In order of risk, the following types of mutual funds are commonly available:
- Money market funds (lowest risk)
- Fixed income funds
- Asset allocation and balanced funds
- Equity funds (highest risk)
Money market funds
These funds involve relatively low degree of risk. They invest in short-term debt securities such as government Treasury bills and other high quality securities that have a term to maturity of less than one year.
Money market funds normally strive to maintain a constant unit value, can provide regular monthly distributions and are often used by investors who have a short time horizon and low risk tolerance.
Fixed income funds
These funds are riskier. Fixed income funds invest in bonds and other debt securities and have the potential for growth while striving to provide a regular level of income. Maturity dates on the holdings typically tend to be longer than those investments held in a money market fund.
In addition to government debt, fixed income funds may also buy corporate debt generally rated BBB+ or higher by bond rating agencies. Such bonds are called investment grade because they carry a lower risk of default. Bonds that are less than investment grade may form part of a high-yield bond portfolio. They pay higher interest – but have greater risk of default.
There are a wide variety of fixed income funds available which can focus on specific geographic regions, credit quality, term to maturity or fixed income securities.
Asset allocation and balanced funds
Asset allocation and balanced funds involve moderate risk and are a mix of equities, bonds and cash equivalents. Balanced funds target a fixed allocation of these assets, while asset allocation funds will adjust the asset mix based on current market conditions.
Target date funds (also known as life cycle funds) are a type of asset allocation fund. In a target date fund, the asset mix is adjusted automatically on the investors' behalf. As the target date gets closer, the portfolio becomes more conservative.
For example, a target date fund might start out with an asset allocation that is split evenly between stocks and bonds – to maximize exposure to higher-growth equities at the beginning of the investment period. As each year passes, more and more of the equity portfolio is sold to buy bonds – to reduce the risk. At the end-point, the fund might be entirely invested in bonds and money market funds.
At the top of the risk spectrum are equity funds. They hold the potential for the greatest return but are generally far more volatile than fixed income funds. Equity funds may concentrate on specific countries or specific regions such as emerging markets or Asian markets (excluding Japan).
Funds that invest across the world come in two forms. Global funds can invest in every country. International funds exclude the U.S. and Canada.
Equity funds also come in a variety of styles. Some may focus on growth stocks – companies that are expected to boost their earnings every year. Some may focus on value stocks – companies that are out of favour in the stock market. Other funds may blend both styles.
Additionally, equity funds may focus on different market sectors. Some funds may target large capitalization stocks – the biggest companies, which are often household names. Others may invest in smaller capitalization stocks with potentially higher growth rates than large cap stocks. Keep in mind – small cap stocks are also more volatile.