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Stock mutual funds, as their name implies, invest in stocks. These funds are often referred to as equity funds. Equity (not to be confused with equity in real estate) is another word for stocks.

Stock funds and the stocks that they invest in usually are pigeonholed into particular categories based on the types of stocks they focus on. Categorizing stock funds often is tidier in theory than in practice, though, because some funds invest in an eclectic mix of stocks. Here are the major ways that funds and the stocks that they hold differ from one another:

If Size of company. Just as you can purchase shirts or sweaters in small, medium, and large sizes, you can purchase stock in small, medium, and large companies. The size of a company is defined by the total market value (capitalization) of its outstanding stock. Small companies are generally defined as those that have total market capitalization of less than $1 billion. Medium-sized companies have market values between $1 billion and $5 billion. Large-capitalization companies have market values greater than $5 billion. These dollar amounts are somewhat arbitrary. (Note: The term "capitalization" is routinely shortened to "cap," as in small-cap company or large-cap stock.)

Why care what size of companies a fund holds? Smaller companies typically pay smaller dividends but appreciate more. They have more volatile share prices but tend to produce greater total returns. Larger companies' stocks tend to pay greater dividends and on average are less volatile but produce slightly lower total returns than small company stocks. Medium-sized companies, as you may suspect, fall between the two.

f Growth or value? Stock fund managers and their funds are further categorized by whether investments are made in growth or value stocks. Growth stocks are public companies that are experiencing rapidly expanding revenues and profits. These companies tend to reinvest most of their earnings in the company to fuel future expansion; thus, these stocks pay low dividends. For example, IDG Books Worldwide, Inc. (the company that published this book) reinvests much of its profits back into publishing more good books. (You can't buy stock in IDG though, because the company is private.)

Value stocks are public companies priced cheaply in relation to the company's assets, profits, and potential profits. It's possible that such a company is a growth company, but that's unlikely because growth company stocks tend to sell at a premium compared to what the company's assets are worth.

Geography. Stocks and the companies that issue them are further categorized by the location of their main operations and headquarters. Is a company based in the United States or overseas? Funds that specialize in U.S. stocks are (surprise, surprise) called U.S. stock funds; those focusing internationally are typically called "international" or "overseas" funds.

What do all of those other names mean?

If small and large, value and growth, U.S. and international haven't created enough mind-numbing combinations of stock fund options, here are a few more names that you'll confront.

Start with all the variations on growth. Aggressive growthiunds are, well, more aggressive than the other growth funds. Not only does an aggressive growth fund tend to invest in the most growth-oriented companies, but the fund may also engage in riskier investing practices, such as making major shifts in strategy and trading in and out of stocks frequently (turning over the fund's investments several times or more during the year).

Then consider growth-and-income funds and equity-income funds. Both of these fund types invest in stocks (equities) that pay decent dividends, thus offering the investor the potential for growth and income. Growth-and-income and equity-income are basically one and the same. The only real difference between them is trivial: Equity-income funds tend to pay slightly higher dividends (although some growth-and-income funds have higher dividends than equity-income funds!). They may pay higher dividends because they invest a small portion of their portfolios in higher-dividend securities, such as bonds and convertible bonds.

| Incomo funds tend to invest a healthy portion

I (but by no means all) of their money in higher-

i yielding stocks. Bonds usually make up the other portion of income funds. As you see later in this chapter, other fund names designate those funds investing in both stocks and bonds — names such as balanced funds. Income funds are really quite similar to some balanced funds.

The term international typically means that a fund can invest anywhere in the world except the United States. The term worldwide or global generally implies that a fund can invest anywhere in the world, including the United States. I generally recommend avoiding worldwide or global funds with just one managerfor two reasons. First, it's difficult for a fund manager to thoroughly follow the companies and financial markets across a truly global investment landscape. (It's hard enough to follow either solely U.S. or solely-international markets.) Second, most of these funds charge high operating expenses — often well in excess of 1 percent per year — which drags down investors' returns.

Don't get bogged down in the names of funds. Remember that funds sometimes have misleading names and don't necessarily do what their names may imply. What matters are the investment strategies of the fund and the fund's typical investments. I tell you what these strategies are for the funds recommended in this book and show you how to combine great funds together into a portfolio in Chapter 10.

By putting together two or three of these major classifications, you can start to appreciate all of those silly and lengthy names that mutual fund companies give to their stock funds. You can have funds that focus on large-company value stocks or small-company growth stocks. These categories can be further subdivided into more fund types by adding in U.S., international, and worldwide funds. For example, you can have international stock funds focusing on small company stocks or growth stocks.

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Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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