Domestic Diversified Stock Mutual Funds

The largest mutual funds are diversified U.S. stock mutual funds that invest in the common stock of large U.S. corporations. These domestic stock mutual funds are the most common selection for first-time investors and provide a excellent core investment for any portfolio.

You should note that the term "equity" is often used in lieu of "stock", as stock represents the ownership of equity in a company. Also, a firm's assets are financed with a mixture of debt and equity, with the equity portion being raised through the sale of stock, a.k.a. equities. So a stock mutual fund and an equity mutual fund are the same thing.

The details of how stock mutual funds are classified, or categorized, are discussed at length in Mutual Fund Classification Criteria., Mutual Fund Categories and The Categorization of Stock Funds. As you can refer to those subsections for the details, I won't add to the volume of this subsection by repeating them here.

The Russell 1000 index includes the 1000 largest U.S. corporations, which account for 92% of the total U.S. market capitalization. The S&P 500 index, which is a subset of the Russell 1000, includes the largest 500 U.S. corporations and accounts for 72% of the total U.S. market capitalization. There are about 400 large-cap stocks and 800 mid-caps, so the Russell 1000 includes all of the large-caps and top ¾ of the mid-caps. Therefore, it shouldn't be too surprising that stock mutual funds that invest in this pool would be many in number and include some of the largest mutual funds.

Large-cap stock mutual funds vary in the breadth of the market caps they bracket. Some stick exclusively to the 400 or 500 largest firms, others dip a ways into the mid-caps and some span the top 1000. The breadth of a fund's market capitalization bracket will be noted in its prospectus, but pay attention to the breadth of the majority of the fund's holdings and don't be mislead by a few outliers.

Large-cap stock mutual funds make an excellent core holding and also are a good selection as your first mutual fund. But remember that their prices tend to fluctuate with the general market, so without other holdings to provide diversification and moderate the effects of market volatility, you, too, will experience that volatility.

Many large-cap stock mutual funds are comprised of stocks that pay above-average dividends. The dividends from these mutual funds provide a source of income and help support the NAV of the funds during market declines or protracted bear markets. You should note that there are two primary reasons for stocks having relatively high dividend yields: 1.) The company is maturing and its pretax earnings exceed its need for capital to fund new projects or products and the excess net earnings are paid to shareholders as dividends. 2.) The company's price is currently depressed for some reason but the dividend has not been cut. If the company is healthy, then it may be a good value investment. For this reason, large-cap value funds quite often have relatively high dividend yields.

Mid-cap stock mutual funds usually restrict themselves to the approximately 800 companies in the mid-cap category, but some may reach a ways into the large-caps or the small-caps, depending on the funds' stated objectives and strategies and the fund managers' preferences. The mid-caps are not as small as their name may imply, as they include firms with market capitalizations ranging from $2 billion to $10 billion.

Some people shy away from the mid-cap category because they feel that the mid-cap companies are in limbo and include companies whose growth ended before they attained large-cap status. Others believe that tomorrow's large-caps can be found in today's mid-caps. I think there's some validity in both theories and there are probably a few rising stars that are just passing through as they rise from small to large. As with any category, there will always be some good buys to be found by skilled analysts.

Small-cap stock mutual funds invest primarily in the approximately 2000 small-cap stocks, which are often represented by the Russell 2000 index. If you're a purist, you may take exception to this, as the Russell 2000 includes the 200 smallest mid-caps and excludes the 200 smallest small-caps, thus somewhat redefining the small-cap category. As the stocks that comprise the Russell 2000 only account for 6% of the total U.S. market capitalization, it's easy to see why many small-cap mutual funds extend their capitalization bracket well into the micro-caps and also why these funds tend to be relatively small.

There are between 11,000 and 15,000 publicly traded U.S. Companies, depending on who's counting. The reason that it's hard to pin down the number is that there are only about 7200 stocks that are actively traded and for which data is readily available. The Wilshire 5000 index, which currently includes the 7200 or so largest U.S. corporations and accounts for over 99% of the total U.S. market capitalization, is commonly used as a proxy for the total U.S. stock market. The Russell 3000, which is the aggregate of the Russell 1000 and the Russell 2000, accounts for 98% of the total U.S. market capitalization, so the next 4200 companies account for less than 2% of the total U.S. market capitalization. Thus the lead-in to micro-cap mutual funds.

After eliminating the Russell 1000, the Russell 2000 and the smallest 200 small-cap stocks, there are about 4000 other U.S. companies whose stocks are actively traded. These are the micro-caps. Although large in number, these micro-cap stocks only account for somewhat less than 2% of the total U.S. market capitalization. Needless to say, the micro-cap mutual funds tend to be rather small, as taking a large position in any one company would affect the price of the stock of that company and, with the total pool being only 2% of the total market cap, the opportunities for good investments in the micro-cap category are severely limited in terms of total dollars invested.

Although the opportunities for sizable small- and micro-cap investments may be limited, the number of good opportunities is high. Indeed, over the long term, small- and micro-cap stocks have outperformed large-cap stocks by an average of about 3%. Now, there is a lot of controversy surrounding this, especially in regard to the time periods analyzed, and a lot of people don't want to believe it's so, but the evidence supporting this is pretty solid. Whether you believe that small- and micro-cap stocks outperform large-caps or not, one thing is certain, small- and micro-cap funds, especially value funds, tend to do well when the large-cap funds aren't doing well and vice versa, thus they offer good diversification for your portfolio.

Those of us who don't refute the results of studies that indicate that small- and micro-cap stocks outperform large-cap stocks over the long term, recognize that there are some good reasons for this. The biggest reason is that smaller stocks are not widely followed by analysts. Indeed, many are not followed by any analysts. Also, many small stocks are thinly traded. These two factors can easily lead to mispricing of these stocks, as they are not subject to the intense market forces that larger stocks experience on a daily basis. Mispricing of these stocks presents the opportunity for the managers of small- and micro-cap funds to make excess returns when they discover these gems that have been overlooked by the general market. Of course, it may take some time and possibly a little promotion before others discover these gems and bid their price up to their intrinsic value.

The small- and micro-cap category is a place where an astute, experienced and talented fund manager can beat the market and provide you with high returns while enjoying the benefits of better diversification. You should definitely consider these funds for a small part of your portfolio.

You will find diversified stock mutual funds of all sizes and employing each of the four investing styles: value, growth, blend and aggressive growth. Investing styles are discussed in the classification and categorization subsections and the subsection dedicated to Mutual Fund Investing Styles.

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