by Erik Van Tongerloo

Created on: March 22, 2007   Last Updated: October 13, 2009

Mutual funds are a popular investment instrument and every bank sells different kinds of such funds with different risk levels. Every investor wants to reach the highest return on their investments but it is necessary to keep their risk tolerance in consideration. Every bank will try to offer their clients mutual funds which reached a good performance in the past and which fits their investment strategy. The popularity of mutual funds has grown rapidly and the ease of diversification is maybe one of the most important reasons why people invest in mutual funds.

Every bank wants to sell mutual funds which are successful for their clients and they create almost every month new mutual funds and many people have difficulties to find their way in the market of mutual funds. Many funds look similar and the final decision to pick the best one is really difficult. People often don't understand the differences between the different kinds of mutual funds.

Banks sell mutual funds with different investment strategies and here are some differences which may explain the different kinds of mutual funds:

1 Bond funds

Bond funds are mutual funds which invest in bonds. These funds have a lower risk profile than equity funds and also a lower return. These funds are safer than equity funds but there are still differences between the different types of bond funds. Bonds are a kind of loan of a company or the Government and some types may have a higher risk profile. Some types of bond funds are corporate bond funds, government bond funds, high yield bond funds, municipal bond funds, bonds of emerging markets, inflation linked bond funds, convertible bonds and some others. For example, high yield bond funds and bonds of emerging markets have a higher risk than government bond funds

An important issue if you buy bond funds is the interest rate when you buy these funds. Bond funds invest in bonds and if the long-term rate increases, the value of bond funds will decrease. This looks strange but can easy be explained. The fund manager of bond funds needs to sell bonds for a lower price and buy new ones with a higher interest rate.

A bond fund accumulates interest which can be capitalized or not. Inflation is an important issue; the FED will often increase the short-term interest rate and may cause also a raise of the long-term interest rate. Another important factor is that the growth of the economy is too fast or too slow. These factors will influence the value of bond funds.

2. Equity

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