Most mutual funds invest in stocks, and these are called equity funds. While mutual funds most often invest in the stock market, fund managers don't just buy any old stock they find attractive. Some funds specialize in investing in large-cap stocks, others in small-cap stocks, and still others invest in what's left -- mid-cap stocks.
"Cap" has nothing to do with hat size or what your spouse left off the tube of toothpaste (again). On Wall Street, cap is shorthand for capitalization, and is one way of measuring the size of a company -- how well it's capitalized. Large-cap stocks have market caps of billions of dollars, and are the best-known companies in the U.S. Small-cap stocks are worth several hundred million dollars, and are newer, up-and-coming firms. Mid-caps are somewhere in between.
Mutual funds are often categorized by the market capitalization of the stocks that they hold in their portfolios. But how big is a large cap stock? Formulas differ, but here is one guideline:
- Small-cap stocks < $500 million
- Mid-cap stocks $500 million to $5 billion
- Large-cap stocks > $5 billion
Equity fund managers usually employ one of three particular styles of stockpicking when they make investment decisions for their portfolios. Some fund managers use a value approach to stocks, searching for stocks that are undervalued when compared to other, similar companies. Often, the share prices of these stocks have been beaten down by the market as investors have become pessimistic about the potential of these companies.
Another approach to picking is to look primarily at growth, trying to find stocks that are growing faster than their competitors, or the market as a whole. These funds buy shares in companies that are growing rapidly -- often well known, established corporations.
Some managers buy both kinds of stocks, building a portfolio of both growth and value stocks. This is known as the blend approach.
YAHOO! FINANCE TIP
Yahoo! Finance reports a mutual fund's investment style on its profile page. For an example, see VFINX's profile page.
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