Specialty Funds

Specialty/specialized funds focus their approach to investing. Some funds specialize in an industry, some in geographic regions, some in writing covered calls, etc. 

Investors can buy the Latin America, Europe, or the Pacific Rim fund. They would then hope those regions don't go into an economic slump or suffer a natural disaster. When the fund concentrates heavily in an industry or geographic region, it takes on more volatility.

Most equity funds hold stocks in many different industries. On the other hand, there are sector funds that do exactly as their name implies focus on industry sectors. If we buy a "growth fund," so far, we have no idea which industries the "growth companies" compete in. On the other hand, if we buy the Communications Fund, the Financial Services Fund, or the Healthcare Fund, we know which industry space the companies operate in. Concentrating on just one sector is the definition of aggressive investing. Investment results are unpredictable year by year. So, make sure the investor has a long holding period and high-risk tolerance before recommending sector funds.

There are asset allocation funds for conservative investors. Rather than maintaining one's own mix of, say, 20% large cap value, 20% small cap growth, 40% high-yield bond, and 20% short-term Treasuries and constantly having to rebalance, investors can invest in an asset allocation fund that matches their goals. A similar type of fund is called a balanced fund. Here, the portfolio is always balanced between stocks and bonds and generally diversified among types of each. There is not a set percentage for us to know here. Rather, the fund's prospectus would explain the parameters established by the board of directors.

A popular way to invest these days is through age-based portfolios or lifecycle funds. These funds shift the allocation from mostly-equity to mostly-fixed-income gradually as the investor gets closer and closer to his goal of retirement. Another name for these investments is target funds. If she plans to retire in or around 2050, for example, the individual would invest in the Target 2050 fund offered by a mutual fund family. The investments would be diversified, and that mix would become more conservative as we get closer and closer to the year 2050.

529 Savings Plans typically offer an age-based portfolio that is much more aggressive for kids 0-6 years old than those who are now 18 and in need of the funds. For example, the allocation for the youngsters might be 90% equity/ 10% fixed-income, while those 18 years old would be in a portfolio closer to 70% fixed-income/20% money market/ 10% equity.

Both international and global funds appeal to investors who want to participate in markets not confined to the U.S. The difference between the two is that an international fund invests in companies located anywhere but the US. While a global fund would invest in companies located and doing business anywhere in the world, including the U.S.

When investors move away from the U.S., they take on more political risk as well as currency exchange risk. For developed markets like Japan and Singapore, the political risk would be lower than in emerging markets such as Brazil and China. Both types of markets, however, would present currency exchange risk to U.S. investors.

Precious metals funds allow investors to speculate on the price of gold, silver, and copper, etc. by purchasing a portfolio usually of mining companies who extract these metals. Since a mine's costs are fixed, it only makes sense to open them for production when the price of what you're mining goes high enough to make it worth your while. Therefore, these funds typically hold stock in mining companies as opposed to hold¬ing precious metals themselves.

What if the investor does not believe portfolio managers are likely to beat an index such as the S&P 500 with their active management over the long-term? 

He can buy an index fund that tracks an index as opposed to a fund trying to trade individual stocks. An index is an artificially grouped basket of stocks. 

Why are there 30 stocks in the Dow Jones Industrial Average, and why are the 30 stocks that are in there in there?

Because the company who put the index together says so. Same for the S&P 500. S&P decided these 500 stocks make up an index, so there you have it. Investors buy index funds because there are no sales charges and low expenses. Since there's virtually no trading going on, the management fees should be and typically are low so, for a no-brainer, low-cost option, investors can put their money into an index and expect to do about as well as that index.

Well-known indexes include the Dow Jones Industrial Average. The "Dow" is price-weighted, which means the stock price itself determines how much weighting the stock receives within the index. If a stock trades at $100, for example, its weighting is much higher than a stock trading at $11 per-share. The S&P 500, like most indexes, is market-cap-weighted. The share price of MSFT doesn't matter, but the fact that all their outstanding shares are worth, say, $200 billion means MSFT could be weighted 20 times more heavily than other stocks within the index. Because the S&P 500 contains such a large percentage of the major stocks trading on the secondary market, its movement is considered to represent the movement of the overall stock market. We mentioned this when looking at beta, which measures how much one stock moves compared to the overall market, as measured by the S&P 500.

Neither the Dow nor the S&P 500 cares whether the stock trades on the NYSE or NASDAQ It's the size of the company and the market cap that matter here. And, all 30 stocks within the Dow Jones Industrial Average would also be included with the 500 stocks in the S&P 500.

The most famous "Dow" is the Dow Jones Industrial Average (DJIA). But, there is also the Dow Jones Transportation Average and the Dow Jones Utility Average. Together, these three make up the Dow Composite, which provides what the publishers of the indices call a "blue-chip microcosm of the US. Stock market."

Another well-known market-cap-weighted index is the NASDAQ 100. This index represents the 100 largest non-financial company stocks, all trading on NASDAQ Stocks such as Facebook, Google, Microsoft, and Amazon are found here.

A well-known small-cap index is the Russell 2,000. There are also bond indices for bond investors who want to pay low management fees and engage in passive investing.

Open-end index funds are for long-term investors. If an investor wants to do as well as one of the indices above, this is where he goes. But, because it is an open-end fund, the shares must be redeemed, with everyone who redeems that day receiving the same NAV next calculated by the fund. 

Exchange Traded Funds (ETFs) are another low-cost way to match the performance of an index, only these shares are traded throughout the day just as shares of MSFT or IBM are traded throughout the day. 

For a small investment of money, the open-end index funds are more cost-effective because the ETFs charge commissions. 

An investment of $100 into an ETF would be a bad move, even if the commission were just $9. That is like a self-imposed 9% front-end load! But, for investments of several thousands of dollars, the ETF is at least as cost-effective as its open-end cousin.