(For a more specific list of types of mutual funds, check out the previous lesson.)

Index Funds:
An index fund is a fund (a collection of stocks and/or bonds) that is designed to mimic the performance of a large chunk of the stock market.  For example, you can buy a single fund that will, basically, grab the entire
S & P 500 for you.  This keeps you very diversified.  Also, index funds typically have very low expenses, so you win there too.  You can even get index funds to mimic specific categories -- like large blend or real estate.  If you don't have time to learn a lot of details about investing, index funds are a great way to invest.

Life Cycle / Target Retirement Funds:
If you want to do one-stop, no-fuss-no-muss shopping for your investments, life cycle (target retirement) funds are for you.  They are a pretty new thing for most investment companies, but they are the new buzz.  Here's how they work:  How old are you?  Let's say you're 20...  So, you're going to retire in about 2050...  You can buy just one fund and it will always (supposedly) be perfectly balanced and with the appropriate risk for your age.  

When you are 25, the fund will be a large percent of stocks and include some high risk stuff...  When you are 45, the fund will be less stock and more bonds (which are safer) and the risks will be on the average side...  When you are 60, the fund will be mostly bonds with a little stock and everything will be pretty low risk.  The key with these is to buy them with a company you can trust.  AND you'll want to have a good manager since you are, basically, trusting him with your retirement!  Of course, you don't have to put all your money into one of these -- you can always just have this as part of your portfolio.

UPDATE:  I've learned something new about life cycle funds since I first wrote this...  Just like a mutual fund is a box of stocks (and maybe bonds), a life cycle fund is a box of other mutual funds from the same company!  I was thinking of buying one...  So, of course, I started investigating!  I got the list of funds INSIDE the fund.  I started to investigate each fund (there were about 25 of them)...  The first thing I did was to check their Morningstar rating...  To my shock, all but one of them were only 2 and 3 stars!  (One was 4.)  There is no way on earth that I would buy a 2 or 3 star fund, so why would I buy a big box of 25 of them? 

It almost makes me wonder if these life cycle funds were created just so SOMEONE would buy all those inferior mutual funds -- even if they don't know they are doing it!  So, investigate what's IN the fund before you buy it!

Exchange Traded Funds (ETFs):
These are a lot like index funds in that they track big indexes like the S & P 500 or mid-caps...  But you buy and sell them like a stock -- anytime during the day on the American Stock Exchange.  (Mutual funds can only be sold at the end of the day.)  ETFs can be sold short and you can even buy them on margin...  Anything you can do with and to a stock, you can do with an ETF.  They have cool names too, like Spiders (SPDRs), VIPERs, Qubes and Diamonds.  ETFs usually have fewer expenses than index funds, but you have to pay a fee to buy and sell them (just like with stocks.)  If you don't have the usually $1000+ entrance fee for a mutual fund, you may want to try these because you can get in really cheaply...  You can even buy just 1 share!

Unit Investment Trusts (UITs):
Unit investment trusts (UITs) are, pretty much, like exchange traded funds (ETFs) except that they have a termination date.  Yep, they expire and, when that end date comes, you have to sell -- whether it's a good time to sell or not. 

Real Estate Investment Trusts (REITs):
These act like exchange traded funds (ETFs), but they specialize in real estate.  There are three types: equity REITs (these invest in and own real estate), mortgage REITs (these loan money to others in the form of a mortgage) and hybrid REITs (which are a blend of equity and mortgage).