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Apr 29, 2025

Basics

Types Of Investment Funds: To Each Their Own

How do you choose an investment fund? What are the main types of this appealing and complex financial instrument? In this article we will break down the differences between them and explain the best options for various goals.

What is an investment fund?

Imagine a big basket of assets: stocks, bonds, real estate, etc. that combines the capital of several different investors (people as well as companies). This is an investment fund — a diversified financial instrument managed by a professional. Think of it like a group road trip: everyone chips in for gas, and an experienced driver (the fund manager) takes you all to a profitable destination. It’s a great tool that allows you to spread the risks and potential returns that could be greater than direct investment. In modern financial markets investment funds provide liquidity, diversification, professional management, and access to foreign markets.

In a nutshell, why use an investment fund?

You don’t need to be a finance expert — professionals manage it aiming at the goals of the fund — growth, income, or a specific method.
You can start with a small amount of money.
Your risk is spread across many investments, making it safer than putting all your money into one asset.

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The main types of investment funds

Mutual funds

A mutual fund pools money from many investors and creates a diversified portfolio of stocks, bonds, or other securities. It is managed by professionals and usually updated daily. Mutual funds tend to be open-end funds, issuing new shares when money is contributed and redeeming shares when money is withdrawn. The share price is linked to the net asset value (NAV) at the end of each trading session. For example, the Vanguard 500 Index Fund (VFIAX) – a popular mutual fund tracking the S&P 500. Investors buy or sell mutual fund shares directly with the mutual fund (or through brokers) at the daily NAV price, not on an exchange.

Mutual funds are great for diversification and retirement portfolios, and they’re popular with long-term holders, but they come at a cost: there are management fees (expense ratios) that vary by mutual fund.

There are different types of mutual funds focusing on different assets:

Equity mutual funds (investing in stocks).
Fixed-income mutual funds (investing in bonds).
Money market mutual funds.
Blended mutual funds that combine assets.

Index funds

An index fund is a type of mutual fund that seeks to follow a market index (like the S&P 500) rather than trying to beat it. The idea is to pool money from many investors and create a portfolio that closely resembles the makeup of a target index to match its performance.

It’s a great tool if you need a low-maintenance passive investment option — the fund owns the same stocks (or other securities) in the same percentages as the index, and it usually has very small operating expenses and fees. It involves minimal decision-making — essentially, the plan is on autopilot.

With an index fund you can replicate all types of indices: broad stock market benchmarks, bond indices, foreign market indices, or more targeted indeces that focus on specific sectors or factors. You get a low-cost, diversified investment that will rise or fall in line with the overall market segment it is modeling. For example, an S&P 500 index fund will deliver nearly exactly the same return as the S&P 500 itself (pre-fees).

Exchange-traded funds

Top ETF performers as of 4/01/25

An exchange-traded fund, or ETF, is a portfolio that might track a market index or sector, commodity, or investment style. For instance, the SPDR S&P 500 ETF (SPY) is one of the most popular ETFs that tracks the S&P 500 index. ETFs are similar to stocks in that they are traded on an exchange, and because of this their share price changes throughout the day based on supply and demand. Most ETFs attempt to match an index's performance passively, but some are actively managed.

ETFs usually have lower expense ratios than mutual funds and are more tax-efficient. ETFs are a good option if you seek flexibility and liquidity: you can buy or sell shares through a brokerage anytime the markets are open.

The difference between an index fund and an ETF is that the former has the same buy and sell price, while an ETF has the offer and bid — buying and selling prices. The gap between them is called a spread.

Hedge funds

Hedge funds are like high-risk, high-reward and privately managed investments for wealthy investors. Hedge funds usually attract institutions or individuals with high income or net worth, and sometimes you’ll need to tie up your cash over a period. They also charge higher fees, usually a management fee plus a performance fee (a proportion of profits).

Unlike mutual funds or ETFs, hedge funds usually have less restrictive regulation, so they can be invested in a wide range of asset classes (stocks, bonds, commodities, derivatives, etc.)

The potential for huge profits comes with an equally big potential to lose money. Hedge funds are suitable for more experienced investors: they often seek absolute returns (profit independent of the state of the markets) and use flexible and aggressive strategies (like shorting and leverage) to make big profits.

While the business of hedge funds has grown to the point where it manages trillions of dollars around the globe, it remains a niche sector for experts seeking alternative strategies.

Money market funds

For those looking to store cash with a bit of interest, money market funds are ideal.

They are low-risk mutual funds that invest in very short-term, safe investments like U.S. Treasury bills, corporate debt, and bank certificates. These funds usually keep their price stable (around $1 per share NAV in the U.S.) and are used as a secure and well-diversified place to park cash. They invest in debt with maturities typically less than 1 year and with low credit risk and are much less volatile. Also the money is easily accessible.

While you won’t get as much profit as with stocks or bonds, money market funds provide an excellent opportunity to store cash with minimal risk or to use them as a safe haven when the stock market is unstable or interest rates rise.

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Private equity funds

These funds invest in private companies (or public companies going private) and help them grow before selling them for a profit. For example, one of the major private equity firms is Blackstone.

Private equity funds raise money from large investors and use it to grow businesses, restructure them, and eventually sell them for a profit. These funds usually require investors to lock in their money for long periods (5-10 years, sometimes longer) — private companies take time to grow. Private equity funds can invest in startups, expanding companies, or even buy companies using borrowed money. Again, while they come with high risks, they also offer the potential for big profits, because the ultimate value depends on successfully growing and then selling off companies in the investment portfolio. Private equity has become a huge industry, worth trillions of dollars worldwide.

Some common strategies investors use in managing this type of fund are:

leveraged buyouts (leveraging on debt to acquire companies),
venture capital (investing in start-ups), and
growth capital (investing in expanding companies).

Just like hedge funds, the private equity sector is not for everyone — the funds charge high fees and demand significant expertise.

Real estate investment trusts (REITs)

A real estate investment trust, or REIT, is a company that owns or finances income-producing property: office buildings, apartments, shopping malls, hotels, or mortgages. REITs allow individuals to hold income property without actually owning property. It’s like owning a piece of a giant hotel chain — you don’t manage the hotel, but you get a share of the profits. By law, most REITs must give at least 90% of their taxable income to investors as dividends, making them a popular choice for those looking for regular income.

There are different types of REITs: some own physical buildings and collect rent (equity REITs), some invest in property loans (mortgage REITs), and some do both (hybrid REITs). REIT shares are quite liquid relative to owning property directly — you can trade them on public stock exchanges.

Their value depends on property prices and interest rates, but over the long run, they have been a solid investment choice, offering both income and diversification in a portfolio. However, they involve little reinvesting of profits (most profits get paid out).

REITs prices can be affected by the conditions of the property market and interest rates.

The choice of the investment fund depends on your goals — identify them to make the best decision.

Types of investment funds: a comparison chart

Let’s compare different types of investment funds and break down their features.

Fund type	Typical assets & strategy	Risk level	Liquidity	Target audience
Mutual funds	Stocks, bonds, or mixed assets. Strategies can be active or passive depending on the assets.	Depends on the asset class: stock funds come with high risks while bond funds typically have lower risks, etc.	Very liquid (can be sold and bought daily at NAV).	Retail investors or a broad range of institutions.
Index funds	Tracks a certain market index (stocks or bonds).	Matches market risk (for example, an S&P 500 index fund has the risk of the stock market).	Very liquid (traded daily).	Retail investors or a broad range of institutions.
ETFs	Can include various assets like stocks, bonds, commodities, futures contracts, currencies, etc.	Varies (depends on the index and the assets).	Very high (traded intraday on exchange).	Retail investors, including traders, or a broad range of institutions.
Money market funds	Short-term government and corporate debt, cash equivalents.	Low risk (aims to preserve capital).	High liquidity (can withdraw anytime).	Retail (cash management), corporate treasuries, etc.
Hedge funds	Can include a wide range of assets: long or short equities, derivatives, global macro, etc. Actively managed.	High risk (demands adopting leveraged and complex strategies).	Low liquidity (lock-ups; periodic redemption).	Accredited investors, institutions (exclusive).
Private equity funds	Private company equity (buyouts, venture capital). Actively managed.	High risk (includes company/business risk, leveraged buyouts).	Very low liquidity (the capital is locked for 7-10+ years).	Institutions, HNW individuals (exclusive).
REITs	Investment in real estate properties or mortgages (with legal REIT structure).	Moderate (includes real estate market risk: prices can fluctuate).	High for public REITs (traded like stocks); low for private REITs.	Retail (via public REITs), institutions (insurance, pensions).

Investment funds: FAQ

What are the 4 main types of investments?

Stocks (equities).
Bonds (fixed-income).
Cash or cash equivalents (e.g. savings deposits, money market instruments).
Real estate (property).

Some cite commodities or alternative assets (for example, crypto) as separate classes, but the main categories are the ones listed above.

How do investment funds make money?

Investment funds make money in two main ways:

Capital gains. If the value of the assets in the fund increases, the fund’s value goes up, and investors can sell their shares for a profit.
Dividends or interest. Some funds pay out earnings from stocks (dividends) or bonds (interest) to investors.

Are investment funds risky?

Remember: every investment tool comes with its own risks, but the level of risk depends on the type of fund.

Low risk options: money market or bond funds.
Medium risk funds: balanced (mix of stocks and bonds) or index funds.
High risk instruments that require expertise: hedge funds, private equity funds, sector-specific funds.

Diversifying your investments and seeking advice from a professional helps manage risk and gain more profit.

How much money do I need to start investing in a fund?

It depends on the fund. Some mutual funds require a minimum investment up to $500 or $1000, while ETFs can be bought with as little as the price of one share.

How do I choose the right investment fund?

Consider the following:

Your main goal. What are you focused on — long-term growth, income, or stability?
Your risk tolerance. Can you handle ups and downs in the market or are you a conservative investor who wants the safest option available?
Fees. How much are you ready to pay in fees?
Fund performance. Look at historical returns, but remember: past performance doesn’t guarantee future results.

Index funds and ETFs are great for beginners — they have low fees and broad diversification.

Summary

The world of investment funds is vast and diverse, and every investor — both novice and pro — can find a suitable option. Beginners might prefer broad ETFs or mutual funds as a simple way to get started, while seasoned investors seeking additional return or alternate exposures might prefer more sophisticated tools like hedge funds or private equity. Analyzing and understanding the market can help investors make better decisions and create portfolios that will best serve their financial goals and risk tolerance.

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