I want to invest in a Mutual Fund. But where do I start?
As discussed in the previous post, Mutual Funds (MF) have become the talk of the town when it comes to investing. Even the financial advisors these days advise moving a significant portion of the investment corpus to MFs, from the traditional avenues like insurance policies, fixed deposits, etc. I have interacted with many people, mostly salaried individuals, on MF investments and have realised that two of the main reasons for investing in MFs is peer pressure & FOMO. A lot of people have been investing in MFs without specific financial goals just so that they don’t stand out from the crowd albeit in an undesirable manner. Investments are to be made with specific financial goals, as different financial instruments differ in risks & rewards and it is necessary to match your investments with your financial objectives/goals. MFs as an asset class have the ability to meet most of the investment objectives of an investor. Hence, let’s begin with the basics of Mutual Funds.
A Mutual Fund involves the pooling of money from various investors and investing the pooled amount in various asset classes such as stocks, bonds, money market instruments (short-term debt instruments), etc. These funds are managed by professional money managers, whose main aim is to maximise capital gains/income for the investors. The investment allocation of each fund is made according to the objectives of the specific scheme— equity, debt, liquid, hybrid, etc.
Now we shall talk in brief about 3 broad types of MFs:
- Equity Mutual Funds
- Debt Mutual Funds
- Hybrid Mutual Funds
Equity Mutual Funds
As the name suggests, an Equity Mutual Fund is a Mutual Fund scheme that primarily invests in the equity shares of the various companies. Equity Funds can be Active or Passive. In an Active Fund, the fund manager screens the market for stocks, conducts research and financial analysis and finds the best stocks to invest in. However, in a Passive Fund, the fund manager tracks a particular market sector or index to select a list of stocks to invest in. A fund manager has no active role in stock selection as the fund’s portfolio allocation predominantly mirrors that of the respective index.
Equity Funds can be further divided depending on the Market Capitalisation, i.e. total market value of the outstanding shares of a particular company. There can be Large Cap, Mid Cap, Small Cap, or Multi-Cap Funds. The Fund Manager invests in companies with a market capitalisation as per the objective of the scheme. Also, Equity Funds are further classified as sectoral/thematic, where investments are restricted to a specific sector (eg — Infrastructure Fund, Pharma Fund) or a specific theme (eg — Consumer Fund or Opportunities Fund). Equity Mutual Funds are the riskiest of all types of Funds, but they also have potential to generate the highest returns.
Debt Mutual Funds
A Debt Mutual Fund scheme invests in fixed income securities such as corporate bonds, government securities, treasury bills, commercial paper and other money market instruments. These funds offer comparatively less capital appreciation against equity funds but provide relatively stable returns. Other advantages of debt Mutual Funds include low cost structure, relatively high liquidity and reasonable safety. They are ideal for invetors who are risk-averse and provide a better alternative to traditional investments like fixed deposits.
Hybrid Mutual Funds
Also known as Balanced Funds, Hybrid Mutual Funds are a combination of debt and equity investments designed to meet the investment objective of the scheme. The purpose of hybrid fund is to provide regular income to its investors along with capital appreciation in the long term. Hybrid funds are riskier than debt funds but safer than equity funds and hence tend to offer better returns than debt funds. They are ideal for investors who are a little risk averse but also want to take advantage of capital appreciation offered by equity instruments.
That was a brief overview on the three broad types of Mutual Funds. We shall delve deep into each of them in upcoming posts.
In the next post we will explore different kinds of equity funds in detail and understand the investment objectives.
