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Growth Vs. Value Investing and Fund Choices

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Recall that mutual funds are collections or portfolios of individual stocks and bonds. The unique selection of stocks and bonds that make up each fund determines it's value. The decision making process that went into selecting the individual stocks and bonds for the fund is important in helping to maximize the value of that fund, because careful systematic choices are more likely to pay off than haphazard choices (assuming that your selection criteria are any good).

Broadly, there are two philosophies that fund managers use when putting together fund portfolios: Value and Growth philosophies. Value funds are mutual funds that target stocks they believe to be undervalued and which should increase in value over time as the market's appreciation of their true value becomes better known. The theory is that value stocks are trading below their actual worth and that the market will eventually correct this "mistake" by raising the cost of purchasing such stocks. When this happens investors with value stocks in their portfolio will realize a gain. You need to hold on to value funds in order to make a profit from them. Owning value funds comes with a moderate risk.

On the other hand, Growth funds target stocks that are expected to grow consistently over time. These stocks are not undervalued as with value stocks, but instead are stocks that appear to have good potential for long-term growth. The risk associated with Growth funds is relatively high. Although the companies whose stocks are in the fund are established and stable, there is no guarantee that the stock prices of these companies will increase. Growth stocks are the largest category of stocks as most people invest with an eye toward long-term growth.

In addition to pure Value and Growth funds, there are also a variety of mixed selection philosophy funds available for sale, as well as a selection of funds where the portfolios are selected for having particular characteristics, rather than on their potential for growth, or recovery of value:

Aggressive Growth funds only target and purchase stocks that have the highest potential for growth. These are stocks from new companies, companies that operate in riskier industries, and smaller companies that are expected to grow significantly. Aggressive growth funds carry a high amount of risk. You may need a portion of aggressive growth funds in your portfolio to increase growth of your investments, but that proportion should be small.

Specialty funds, as their name indicates, have more narrow, specific goals than any other fund category. Each specialty fund will identify what its investing goals are, which could be anything from technology stocks, stocks from a specific area of the world (e.g., "Latin America"), or stocks from socially aware "green" companies. Because the investment focus of these funds is so narrow, the risk such funds carry is often much higher than with other categories of funds. These funds should comprise only a small portion of your overall investment portfolio.

Income and Appreciation funds are so-called balanced funds that attempt to provide a mix of real-time income and long-term growth. These funds are less aggressive than growth funds because the invest in vehicles that offer fixed income as well as equity stocks. Generally, these funds feature a certain percentage of income stocks and growth stocks, 60/40 for example.

Bond funds are also called income funds. Their holdings are almost exclusively bonds, which provide more consistent income than do equity stocks. These funds will target a variety of bonds from government to corporate. Since they focus primary on income, there is usually little growth in bond funds and, accordingly, there is also less risk. Conservative investors should seek out bond funds. This is not to say that there is no risk involved. There is always the risk that the targeted companies will default on their debt.