Types of Mutual Funds
As with any other person starting investments today, I have had similar questions on types of schemes available from the mutual fund asset management company.
Believe me, there’s a jungle out there. More than 2,500 schemes to choose from. You are spoiled with choices. Without any professional guidance, either we end up choosing the one being marketed heavily with the fat commission for seller or misfit for our scenario. In a worst case, due to so many choices, we drop the idea of investment altogether and continue with bank deposits.
I have been in all of the above situations, I felt like I am a hostage of my money. It’s not that I am at best of the situation now, but certainly better as I learned that choosing best is not the objective I have. It’s not worth to waste time on finding best while I could have earned better return with good one. It certainly requires a separate article. I will link it back when I have it.
But certainly, knowing each category of mutual fund is essential first step forward. So here’s my attempt to list high-level categories of mutual fund investments available.
At high-level, there are three broad categories. Equity, Debt and Hybrid. Now let’s explore them in more details.
The aim of equity funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. Equity funds are also known as Growth funds.
At high-level Equity could be categorized in below sub categories.
E1. Index Fund
These fund’s single aim is to follow investment strategy defined by Indexes like Sensex, Nifty etc. They are considered as passive funds, as fund management has to follow index by books and not venture into research for other stocks to invest. Hence their expenses are also lower because they do not need R&D for next big stock to invest in.
E2. Diversify Fund
These funds invest in the equity of companies across market capitalizations (Large Cap, Medium Cap and Small Cap). These funds have a high potential for capital appreciation and contain risk based on their investment across the market cap. Funds invest in mostly Large Cap are known Large Cap funds and similarly Medium Cap and Small Cap. There are several variations called Focused Fund which invests into limited sets of companies only.
E3. TAX Planning Fund
These funds are mostly same as Large Cap Fund. They provide tax benefits under 80C code for investments and they usually have a longer investment time horizon, 3 years. One can withdraw funds before 3 years but in such case, it will not enjoy tax benefits under 80C. It is also known as Equity Linked Savings Scheme.
E4. Sector Fund
These funds typically are concentrated on a particular sector like Pharma / IT / Infra etc. This kind of funds is not suited for the specialized investor who wants to take sectoral bets.
The aim of debt funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities for capital appreciation are also limited in such funds. Debt fund is also known as Income funds.
At high-level Debt could be categorized in below sub categories.
D1. Liquid Fund
These funds invest in highly liquid money market instruments for very short duration, few days. These funds are suitable for parking surplus money for a very short period of time.
D2. Gilt Fund
These funds invest in sovereign securities like central and state government bonds. These carry no credit risk but are subject to interest rate risks. The prices of these securities fluctuate with interest rate movements. These funds have varying investment periods to suit investor needs.
D3. Income Fund
These funds invest in government securities, corporate bonds and debentures apart from money market instruments. These funds carry a slightly higher risk than gilt funds as they are exposed to credit risk. Income funds come with various investment horizons like ultra-short term, short term, medium term and long term funds to suit varying investor needs.
D4. Fixed Maturity Fund
These have a fixed tenure like deposits, though no return is promised or guaranteed. These funds invest in securities that mature in line with the fund’s maturity.
These funds invest in equities and debt investments in varying proportions. Balanced funds invest predominantly (more than 65% of the corpus) in equities with the rest in debt. These are relatively more stable than pure equity funds.
Monthly Income Plans (MIPs) invest about 75 to 80% of their corpus in debt and the rest in equities. The objective is to aim for steady returns offered by debt with possible capital appreciation offered by equity to provide a kicker to the returns.
Now that we have learned types of mutual funds available, I suggest you to come up with asset allocation strategy based on suitable fund types and enjoy the process of wealth creation.
Inspiration for this article is from itsallaboutmoney site, some parts are copied as it is.
Originally published at The Simple Personal Finance.