Like in all asset classes, there has been a tremendous innovation in mutual funds. There are hundreds of types of mutual funds available in the market. In fact, the idea of a mutual fund was itself financial innovation and looks like innovators have refused to stop the buck.
Mutual funds can be classified on many basis, some are as follows:
Classification by Asset Types: The primary classification that any mutual fund salesman will try to tell you is the asset type a fund invests in. Most mutual funds will give you an option to choose your asset allocation. Common examples are 80 percent stock with 20 percent bonds or 50 percent stock with 50 percent bonds etc. Also there can be fund of funds- a mutual fund which itself invests in other mutual funds. The asset type is important because it determines your risk-return preference.
Given the fact that you have chosen equities, there are funds which will allow you further selection. You can choose mid-cap, small-cap or large-cap stocks too.
Open-Ended vs. Closed-End Funds: These are the two fundamentally different types of funds. Open-ended funds create new shares as new investors come and redeem shares if old investors want to sell. Hence, an investor deals with the fund itself. However, in case of closed-end funds, the number of units is locked in and investors trade amongst themselves i.e. the secondary market.
Classification by Sector: There are mutual funds which target specific sectors, such as energy, technology or retail. You can use them to diversify your portfolio.