Stocks and bonds are the two major investment asset classes, and mutual funds are broadly divided between bond funds and stock funds. A fund provides professional management once you decide what portions of your investment money to put into each category. For a long-term investment outlook, you need to invest in both stocks and bonds.
A mutual fund is managed by an investment company that pools investors' money to own and manage a portfolio of assets. Investors own shares of the fund, and the value of their shares increases or decreases directly with the market value of the stocks or bonds held by the fund. A fund pays out portfolio earnings, such as stock dividends or bond interest, as dividends to the investors.
A mutual fund offers investment in a diversified portfolio as a single investment that's easy to buy, sell and manage. The investor picks the fund, and the fund manager picks stocks or bonds to meet the fund's objectives.
Stocks and Stock Funds
Shares of stock are ownership in publicly traded corporations. Investors buy shares to participate in the sales and earnings growth of a company. Stock market gains come primarily from increases in share prices, but many stocks also pay dividends. The stock market does not increase steadily. Instead it goes through periods of alternating rising and falling prices -- just to make investors a little crazy.
A stock mutual fund buys shares of companies to meet its investment objectives. There are thousands of stock funds. Some cover the broad market, and others focus on certain sectors or investment styles.
Bonds and Bond Funds
Bonds are debt securities issued by corporations and government entities. Investors buy bonds primarily to earn interest income. Bonds are marketable securities, with prices moving up and down based on interest rates and issuer credit ratings -- but generally with less volatility than with stocks.
A bond fund holds a portfolio of professionally selected bonds. Investors buy bond funds based on the type of bonds the fund holds -- federal government, corporate or municipal bonds -- and the dividend yield that the fund generates from its portfolio. The safety of bond funds depends on the types and credit quality of the bonds they own.
Asset allocation means the balancing of your investment portfolio between the primary asset types -- stocks, bonds and cash. Stock and bond mutual funds are one way to get your investment exposure to these two assets. Using funds makes it easy to rebalance your asset allocation after some big gains or a market crash in one of the asset classes.
If you are a younger investor, the guidelines push to having more of your money in stock funds. If you are just young at heart but getting closer to retirement -- or already retired -- you would shift a larger allocation into bond funds.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.