Investors who wish to diversify their portfolios frequently look to mutual funds. Two types of mutual funds investors often buy are growth funds and value funds. Growth funds are funds that invest in companies that are expected to experience high growth in the near term. Value funds are funds that invest in companies that are perceived to be relative bargains. While value funds contain stocks that are trading for prices beneath their actual value, growth funds contain stocks that are likely to become more expensive in the future.
About Mutual Funds
A mutual fund is a collective investment scheme that accepts money from multiple investors and pools it to purchase various stocks, bonds and other securities. Individuals who invest in mutual funds don't own any of the securities they contain. Instead, they own shares of the fund. To determine whether a mutual fund is a value fund or growth fund, investors must examine the stocks that compose it, and review the fund's prospectus.
Value and Growth Funds
Value funds contain stocks that are considered undervalued. Value stocks often have low prices because the industry they represent is temporarily struggling. Investors who choose value funds typically do so because they believe the prices of stocks within it will rise. A growth fund contains stocks that have a high likelihood of increasing in value in the future.
Investors categorize stocks as either value or growth stocks based on their price-to-earnings ratios and price-to-book ratios. The price-to-earnings ratio is the price of the stock divided by the earnings per share, while the price-to-book ratio is the stock price divided by the book value per share. Stocks with low price-to-earnings and price-to-book ratios are value stocks. Stocks with high price-to-earnings and price-to-book ratios are growth stocks.
Investing in a growth fund is typically more expensive than investing in a value fund because the price of a growth fund is based on both the current and future values of the stock it contains. Individuals who wish to invest in both growth and value stocks can purchase shares of a blended mutual fund, which contains both types of securities.
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