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What are growth funds?

If you’re looking for ways to boost your wealth and cash flow, you might be tempted by the promises of a business growth fund. We’ll discuss how these types of funds work, as well as what to look for in a good growth fund below.

Understanding growth funds

A growth fund is a managed portfolio of stocks focusing on companies experiencing high periods of sustainable growth. While other types of mutual funds might focus on dividends or yield income, growth funds are designed to highlight capital appreciation. In other words, a growth fund appreciates more over long-term periods.

Businesses included in a growth fund typically reinvest income into expansion, development, and acquisitions with an eye toward rapid growth. The technology sector is one of the most common areas of investment for growth funds.

For investors to see a significant return on their growth fund investment, it’s important to keep the same eye on the future. Growth funds are best for those who can handle a higher level of risk, and don’t plan to sell for at least five or ten years. This gives the fund time to grow, with capital appreciation being the primary goal.

How growth funds work

So, what types of stocks qualify for inclusion in a growth fund, and how do investors see returns? Stocks that grow at a faster rate than their peers could be included in this type of fund.

For example, if the average tech stock is currently growing at an expected earnings per share of 4% over the next five years, a tech company expected to grow at an 8% rate over the same period would be considered for inclusion in a growth fund.

However, investors usually don’t receive dividend payments from growth stocks. This is because rapidly growing companies prefer to take these earnings and reinvest them into the business instead to further accelerate growth.

There’s also an element of risk to consider with growth funds. While a company might be trading at a much higher growth rate now, this doesn’t mean it will be able to sustain the same rate of growth five years down the line. The stocks will take a hit if growth slows for any reason, be it a general market downturn or product failure. Growth funds have high price-to-sales and price-to-earnings ratios.

Types of growth funds

Although we’ve mentioned the tech industry above, you’ll find growth funds covering a wide range of different sectors and markets. Along with blend funds and value funds, growth funds are one of the main mutual fund types.

To break down the variety of growth funds, investors typically talk about the size of market capitalisation. You’ll have small-cap, mid-cap, and large-cap growth funds to choose from. Large-cap funds represent a high percentage of market share, small-cap the lowest percentage.

Foreign diversified growth funds are also a popular option for those who want to diversify their portfolios with international stocks. At the same time, a local growth fund gives investors the chance to support businesses within their own communities. You could also opt to invest in a targeted local growth fund in a region that’s experiencing rapid growth. 

What to look for in a business growth fund

No matter the type of fund you choose, there are a few features to consider when comparing good growth funds. Here are a few distinguishing characteristics:

  • Growth option: This means that the investor will not receive dividends, instead allowing the company to reinvest any earnings into further growth.

  • Dividend reinvestment option: As with the growth option, earnings are reinvested rather than paid out as dividends. However, in this case they’re used to purchase more shares in the fund. Investors receive more fund units as a result.

  • Dividend pay-out option: Finally, although less common you can find growth funds with dividend earnings. Dividends are paid automatically into a bank account in most cases.

The bottom line

Should you invest in a growth fund? Yes, if you’re interested in funds and don’t mind an element of risk. Diversified growth funds take the guesswork out of the equation and can yield high returns over time, making them a solid addition to any portfolio.

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