But that risk is mitigated when a basket of stocks is held, and growth stock mutual funds allow investors to hold a basket for these companies through a single security. However, these funds have certain expenses and taxable events that investors must know before buying shares. This article will discuss what is a growth mutual fund, which types of companies they hold and who they're best suited for.
Growth stock mutual fund definition
Growth stock mutual funds are a combination of 2 different types of assets. A mutual fund is a collection of stocks, while growth stocks are a specific type of equity with certain attributes that appeal to more risk-tolerance investors. Here's a more detailed description of both.
Growth stock
Growth stocks can be found in every industry and sector, although most growth stock mutual fund holdings tend to concentrate in the tech sector. Growth stocks are companies focusing on expanding their market share by reinvesting profits back into the firm. These companies can run the gamut from large conglomerates to small startups, but the focus is usually on aggressive business growth, hence the name "growth stocks."
Investors buying these stocks want to see profits grow exponentially, and they're often punished by the market when expectations aren't met.
Growth companies tend to be volatile since these stocks are bought for future potential, not current success. They rarely pay dividends since all profits are focused back into the firm and often need cash infusions since earnings can be unsteady. Value stocks are usually considered the opposite of growth stocks since they're older and established companies with steady profits and dividends.
Here are a few examples of growth stocks and their performance over the last market quarter.
Mutual fund
Mutual funds are baskets of stocks you can purchase as a single security. The fund takes in investor dollars and uses this cash pool to buy shares of various companies, depending on the fund's objectives. Some mutual funds invest in the market as a whole, like the Vanguard funds developed by John Bogle in the 1970s. Other mutual funds have a more narrow focus based on the stock sector or company size.
Mutual funds can be actively or passively managed. Actively managed funds have a manager who personally buys and sells stocks based on the goals of the prospectus.
Passively managed funds don't have a manager but instead seek to track and emulate the performance of an index, such as the S&P 500 or the Bloomberg Aggregate Bond index. As a result, passively managed mutual funds tend to have lower expense rates since they only aim to match the performance of their underlying index, not surpass it.
Which style is better? Plenty of evidence says most active managers can't continually beat the indices over time, but outliers like Peter Lynch have had sustained success.
Why choose growth stock mutual funds?
Investors might consider growth stocks for several reasons, but the goal of owning them is the same across the board: outperformance. Growth stocks tend to appreciate faster than stocks in other sectors, but the ride is frequently bumpy. If you can tolerate volatility, growth stocks offer the opportunity to beat market averages over time.
Using a mutual fund means putting together a basket of growth stocks and investing in it as a single asset. Mutual funds offer instant diversification since you own the entire portfolio when you buy a share. Growth stock owners have enjoyed tremendous market returns (just look at the growth-heavy NASDAQ over the last decade). Still, these companies are volatile and heavily influenced by interest rates, inflation and other economic concerns.
Types of growth stocks in a mutual fund
While you can find growth stocks in industries across the sector spectrum, growth stock mutual funds usually have high concentrations in the tech sector.
As a result, companies like Apple Inc. NASDAQ: AAPL, Microsoft Corp. NASDAQ: MSFT and NVIDIA Corp. NASDAQ: NVDA populate the top holdings of many leading growth stock mutual funds. But today, let's look at a smaller company with a more traditional growth focus: Airbnb Inc. NASDAQ: ABNB.
Airbnb has plenty of coverage from analysts, and sentiment has improved over the last few months. Analysts' ratings currently show more "buy" ratings than "hold" ratings for the second consecutive month.
Airbnb stock has been on a ride in the last 12 months. The company stock chart shows that 20% or more gyrations have been commonplace for this volatile growth stock. One of the reasons growth stocks don't appeal to all investors is these violent upswings and downswings that often occur within the same year (or even quarter).
Like most newer growth stocks, Airbnb’s earnings have been all over the place. After a disastrous quarter at the end of 2020, Airbnb began producing better earnings and had a positive EPS by Q3 of 2021. The company has beaten analyst estimates in nine of the last 10 quarters.
Airbnb institutional ownership decreased sharply during a $35 billion exodus in Q3 of 2022. Institutions had been buyers of Airbnb up until that quarter and have increased holdings each quarter since, but they've been net sellers of the stock over the last 12 months, and outflows have outpaced inflows by more than $31 billion.
Example of a growth stock mutual fund
Growth stock mutual funds all have fairly significant overlap in holdings, but you still need to read the prospectus of each and evaluate the concentration of its holdings. Additionally, pay attention to the expense rate. Fund costs can significantly affect your profits over time, so ensure you’re paying a fair rate for the type of exposure you seek. Similar funds often have different expense rates, and you don't want to overpay for the same basket of stocks.
One of the longest-running growth stock mutual funds is the Vanguard U.S. Growth Fund Investor Shares under the ticker VWUSX. The fund has more than $34 billion in assets under management and has been trading since 1959.
With a 0.33% expense rate, the fund is reasonably priced for broad exposure to a basket of volatile growth stocks. The highest equity concentration is in the tech sector (35.5%), followed by consumer discretionary (18.8%), healthcare (14.3%) and communication services (10.7%). The fund's top holdings are large-cap growth stocks like Apple, Microsoft and NVIDIA (Airbnb is the 29th highest weighted holding).
How growth stock mutual funds work
Mutual funds don't trade like stocks or ETFs since they can't be bought or sold on exchanges. To buy a mutual fund, you'll need to place an order with your broker before the end of the day. At the end of each trading day, mutual funds calculate their net asset value (NAV), which determines the price of the individual shares. NAV is similar to the market cap of an ETF and calculated by dividing the fund's total net assets by the number of shares outstanding. But unlike an ETF, this price is calculated once per day.
Mutual funds buy and sell shares to meet demands from investors. For example, if the fund is experiencing outflow, it must sell shares to meet redemptions. Since the fund constantly buys and sells shares and receives dividends, capital gains distributions are made to investors. If you invest in a growth stock mutual fund, you'll receive these distributions whether you sell your shares or not, which could create a taxable event. If you hold your growth stock mutual funds in a taxable account, be sure to keep these distributions in mind.
Growth stocks can be volatile, but the last year has been kind to them, at least compared to the S&P 500. Here's a chart showing the performance of the Fidelity Growth Opportunities ETF BATS: FGRO compared to the S&P 500 over the last 12 months.
Over certain time frames, growth stocks have outperformed the broader market, especially when interest rates are low. Growth companies often need cash, and low rates decrease the hurdles they must leap to acquire it. But now that interest rates are rising, will growth stocks continue this outperformance? Investors will be monitoring this sector closely for the next few quarters.
Alternatives to growth stock mutual funds
Long-term growth mutual funds often make great assets for retirement accounts, but there are alternatives for investors to consider. Here are four different types of assets to compare to growth stock mutual funds before investing.
Individual growth stocks
If you can't find the ideal portfolio in any available growth stock mutual funds, you can build your own and purchase individual shares of growth stocks. Many brokers now offer partial shares of stock so investors with limited capital can still build a diverse portfolio. But buying individual stocks involves lots of research and stomaching plenty of volatility, especially when growth stocks are involved.
Actively managed growth stock ETFs
If mutual funds aren't your ideal vehicle but still want a basket of stocks, you can consider an actively managed stock ETF. These ETFs have a manager selecting shares for the portfolio, much like a mutual fund manager, but ETFs can be sold on exchanges and don't have the unavoidable capital gains distributions.
Growth stock index funds
In addition to actively managed growth stock ETFs, you can purchase plenty of passively managed growth stock ETFs as well. Growth stock index ETFs are often cheaper than their actively managed counterparts and can be traded more easily than mutual funds.
Sector-specific mutual funds or ETFs
Many investors prefer specific sectors or industries instead of themes like growth or value. For example, there's plenty of overlap between tech sector mutual funds and growth stock mutual funds, but the tech sector funds will exclude industries like healthcare and consumer discretionary. Consider a tech sector fund if you prefer a more concentrated focus on the tech sector's growth stocks.
How to select the right growth stock mutual fund
Your financial advisor can help you find the ideal growth stock mutual fund based on your risk tolerance, time frame and investment goals. Just because a mutual fund owns your preferred stocks doesn't mean it's the best vehicle for your investment dollars. Plus, you'll need to consider the type of account (401k account, IRA or taxable account) and select the most tax-efficient assets. Exchange-traded funds (ETFs) might be more suitable in a taxable account than mutual funds.
Bottom line: Always consult with financial advisors before making major asset allocation decisions.
If you prefer not to use a financial advisor, you'll need to learn how to categorize growth stock mutual funds based on your own personal finance criteria. Here are three questions to ask yourself when selecting mutual funds:
- How much risk am I willing to take? Growth stock risk is lessened in a vehicle like a mutual fund, but these are still volatile companies. You'll need to decide how much volatility you can withstand since not all growth stock mutual funds have the same composition. Additionally, you'll need to consider costs like expense ratios, load fees and other charges that can eat into your potential profits.
- Active or passive? Active mutual funds have fund managers picking stocks based on their personal view of markets and the economy. Passive means index funds, which attempt to match the return of a particular stock index. Active funds usually have higher expense ratios than index funds, but some investors prefer to pay up for managers they believe can outperform the market.
- What is my time horizon? Growth stock investors tend to have a long-term investment view since these companies can produce impressive returns, but the path to profitability is often rocky and laborious. Be sure to select funds that share your investment goals and timeframe.
Managing risks in growth stock mutual funds
Mutual funds can mitigate some of the investment risks involved with growth stocks, but no asset can erase risk from the equation.
Instead, you'll need to manage risk based on your goals. Here are a few tips for managing risk with growth stock mutual fund investments:
- Have a diverse portfolio of assets.
- Rebalance your asset allocation on a set schedule.
- Don't let one particular fund become too overweight in your portfolio.
- Revisit your investment goals and timelines if your finances change.
Here's an example: When the Federal Reserve began raising rates to combat inflation, growth stocks in sectors like tech were the first to get hit. A rising interest rate environment is a good time to revisit investment plans and possibly reduce exposure to growth stocks in favor of fixed-income assets that offer high yields.
Once you've invested in a growth stock mutual fund portfolio, you must track your investments to ensure they stay on pace with your goals. Benchmarking is the primary way investors track their performance, which means comparing their returns against the major market averages.
If you invest in actively managed growth stock funds, you'll likely benchmark performance against a stock market index like the NASDAQ 100.
Suppose you hold active funds and find they're underperforming a major growth index like the NASDAQ. In that case, you might consider reducing exposure in those funds or selecting ones with a different investment thesis. Or you could compare the performance of your funds' portfolio manager against competitors in the field.
Exposure to exciting stocks through a single asset
If you don't want to pick your own stocks, a growth stock mutual fund is a good way to build a diverse portfolio.
Growth stock mutual funds are usually more expensive than broad market funds since there's more volatility within the portfolio, but plenty are available for reasonable rates. However, mutual funds have certain tax implications investors should be aware of and may not be the best vehicle for every type of brokerage account. Situations exist where an ETF may be a more efficient way to gain growth stock exposure, so be sure to research the holdings, expenses and tax rules regarding each fund before buying any shares.
FAQs
What is a good growth stock mutual fund? Here are a few important questions investors ask regarding this asset class.
Are growth stock mutual funds risky?
Growth stocks are a risky asset class, but that risk is reduced when purchased through a fund that holds a basket of them. Growth stock mutual funds can still be volatile. However, they’re less risky than having individual stocks.
What is a growth mutual fund example?
The Vanguard U.S. Growth mutual fund is one common example, as the fund has more than $35 billion in assets and has been trading since 1959.
Are growth mutual funds a good investment method?
Growth mutual funds are often good ways to get exposure to the sector, especially through retirement vehicles like 401(k) accounts. Just be sure investment in a mutual fund is the most tax-efficient way to get exposure to growth stocks in your preferred type of account.
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