Mutual funds have increasing become common in India as more people want to create wealth, especially from the stock market. These funds offer easy and flexible ways to create a diversified portfolio of investments. There are different types of mutual funds that offer different options as per the diverse risk appetites of the investors.
It will help us to understand the different types of mutual funds currently available in the market to help us make an informed investment decisions.
In general, any mutual fund will either invest in equities, debt or a mix of both or any other asset as defined by the fund objective. They can be open-ended or close-ended mutual fund schemes.
Open-ended funds - In an open-ended mutual fund, an investor can invest or enter and redeem or exit at any point of time. It does not have a fixed maturity period.
Close-ended funds - These funds have a fixed maturity date. An investor can only invest or enter in these types of funds during the initial period known as the New Fund Offer period. Her investment will automatically be redeemed on the maturity date. Close-ended funds are also listed on stock exchange in case an investor wants to sell it before maturity.
Equity Funds
Various types of equity funds are the most popular funds in our country. They allow various kind of investors to participate in the stock markets. All equity funds are categorized as high risk, but they also have a high return potential in the long run. They are ideal for investors looking to build a portfolio that gives them superior returns over the long-term. Normally an equity fund or any diversified equity fund invests over a spread of sectors to distribute the risk. Equity Funds are either active or passive.
Equity funds can be further divided into four main categories:
Sector-specific funds: These are mutual funds that invest in a specific sector of the economy like infrastructure, banking, mining, etc. These can also be categorized in specific segments like mid-cap, small-cap or large-cap funds depending upon the type of companies they invest in.
Index funds: Index funds are ideal for investors who want to invest in equity mutual funds but at the same time don't want to depend on a fund manager to take any decisions. An index mutual fund only invests in the companies that are included in an index like Sensex or Nifty. You can read my previous post on Index Funds for more details.
Tax saving funds (ELSS): These funds offer tax benefits to investors as a tax deduction u/s 80C of the Income-Tax Act, 1961. They are also called Equity Linked Saving Schemes (ELSS). These funds invest in equities and have a 3-year lock-in period.
International Funds: These invest in companies which are listed outside India. These are high risk funds due to their exposure to equity and also to foreign exchange.
Debt Funds
A debt fund is a mutual fund that invests only in fixed income instruments, such as government bonds, corporate debt securities, and money market instruments etc. Debt funds are also referred to as Fixed Income Funds or Bond Funds. A few major advantages of investing in debt funds are relatively stable returns, high liquidity and reasonable safety.
Debt funds can also be divided into four main categories:
Liquid funds or Money market funds: These funds invest in short-term debt instruments which can give a stable return to investors over a short period of time. These funds are suitable for investors with a low-risk appetite who are looking at keeping their funds over a short-term as an alternative to putting money in a savings bank account.
Fixed income funds: These funds invest a majority of the money in fixed income securities i.e., fixed interest-bearing instruments like government securities, bonds, debentures, etc. These are usually a low-risk and low-return funds and are ideal for investors with a low-risk appetite looking at generating a predictable income.
Monthly Income Plans: In these funds, the higher proportion is invested in debt securities and a small percentage in equity assets. They are also called marginal equity funds. They are suitable for investors who are retired and want a regular income but with comparatively low risk.
Gilt funds: These funds invest only in government securities. Gild funds are preferred by investors who are risk averse and want no credit risk associated with their investment. But the return of the funds can change according to the prevailing interest rates in the economy.
Balanced funds
These are mutual funds that divide their investments between both equity and debt in a single fund. The allocation may keep changing but it stays within the prescribed limit as stated by the objective of the fund. These funds are more suitable for investors who are looking for moderate returns along with comparatively low risk.
Gold Funds
These funds invest their money only in gold or securities backed by gold, like sovereign gold bonds. Their return will fluctuate as the price of gold goes up and down.
Looking at the numerous options available to investors, one can choose to invest in some of these categories of funds after understanding our risk appetite. Investing in mutual funds requires patience and a gradual approach to investing is the best way by using SIPs (systematic investment plans). They are the best way to begin investing in any kind of market conditions.