Understanding The Different Types of Mutual Funds its Benefits
There are many types of mutual funds in India, and each has different purposes. Learn how to invest and why it's essential to choose the right one.
Mutual funds can appear complicated or intimidating to many people. We'll try to simplify it when you're at the most fundamental level. A Mutual Fund is essentially the money pooled in by many people (or investors). An expert fund manager oversees the management of this fund.
It is a trust that collects funds from a group of investors who have a common investment goal. The money is then invested in stocks, bonds, money market instruments, and other securities. Each makes purchase units, a portion of the fund's holdings.
Mutual funds are among the most comprehensive, simple, and adaptable ways to build a diversified investment portfolio. Various types of mutual funds provide different options to investors with varying risk tolerances. Let us examine the various types of mutual funds currently available in the market to assist you in making an informed purchase decision.
What exactly is a mutual fund?
A mutual fund is a professional scheme that collects money from individuals and invests it in various assets. Asset classes are broadly classified as equity, debt, and money-market instruments. The funds raised from multiple investors are typically invested in budgetary securities such as stocks and money-market instruments such as certificates of deposit and bonds.
These investments could be made short, medium, or long term. The risk factor of the funds is also determined by the type of asset invested.
After deducting certain expenses, the income/gains generated from this collective investment are distributed proportionately among the investors by calculating a scheme's "Net Asset Value or NAV."
The mutual fund's market value is its Net Asset Value (NAV). The mutual fund's NAV is its market value per unit. The NAV is calculated every day.
NAV = [Market value of assets minus liabilities and expenses] / number of exceptional mutual fund units.
In India, there are various varieties of mutual funds.
Mutual funds come in a variety of varieties. on the market. Structure, asset class, risk levels, investment objectives, investment horizons, and fund speciality distinguish funds. New investors must understand the distinctions between them.
Equity mutual funds, for example, invest in a company's stock. These funds' returns are generally higher than those of other funds. Still, they may also be riskier—debt mutual funds in fixed-income securities, which provide relatively stable but lower returns. By making an investment in both equity and debt securities, hybrid mutual funds seek to combine the best of both worlds.
Mutual funds can also help you save money on taxes. Section 80C of the Income Tax Act of 1961 allows tax deductions for equity-linked savings schemes or ELSS funds. They do, however, have a three-year lock-in period.
Understanding the differences between various fund types can assist you in selecting the best mutual fund to invest in.
Let's look at the different types of debt and equity mutual funds market in India:
Types of Mutual Funds Based on Asset Class
1. Equity Mutual Funds
As the name implies, equity funds invest in equity markets and equity-based instruments. The funds are invested in a bowl of shares from various sectors with varying market capitalisations.
Equities are likely to provide the highest long-term returns, but they are also the riskiest. These are some of the most well-known mutual fund schemes. They enable stakeholders to invest in stock exchanges. Despite being classified as high risk, these schemes have a good dividend potential in the long run. They are suitable for investors in their main earning stage who want to build a portfolio that will provide them with superior long-term returns. Typically, an equity fund, a diversified equity fund, invests across multiple sectors to spread risk.
Equity funds are further classified into three types:
> Industry-specific funds:
These are mutual funds that invest in a particular industry. These can be sectors such as infrastructure, banking, mining, or specific segments such as mid-cap, small-cap, or large-cap. They are appropriate for investors with a high-risk tolerance and the potential for high returns.
> Index mutual funds:
Index funds are ideal for investors who invest in equity funds but do not want to rely on fund managers. The strategy of an index mutual fund is the same as that of the index on which it is based.
Index funds pledge returns that correspond to the underlying index. Furthermore, they limit the loss to the proportional loss of the index they follow, making them suitable for investors with low-risk tolerance.
> Tax-cutting funds:
These funds provide tax advantages to investors. They invest in stocks and are also known as Equity Linked Saving Schemes (ELSS). They have a three-year lock-in period. Investments are tax-deductible under Section 80C of the Income-Tax Act of 1961.
2. Debt Management Funds
Debt funds invest in fixed-income securities such as corporate debt, government bonds, treasury notes, deposit certificates, and similar instruments. The funds are classified as Secured Maturity Plans (FMPs), Gilt Funds, Short Term Plans, Long Term Bonds, and so on based on the duration of maturity of the instruments.
If you want a more secure investment, a debt fund is a way to go. Compared to other funds, the level of returns in these funds is lower.
3. Money Market Mutual Funds
The cash market is another name for the money market. The stakeholders involved who run the show in this industry are the government, banks, and corporations. These organisations raise funds for their processes by issuing very short-term instruments. These instruments have a high credit rating and are incredibly safe to invest in. Money market funds are more commonly used for cash management or liquidity management. These funds are an attractive substitute for a savings account because they provide returns in the range of 6-7 per cent, are highly safe, and provide liquidity comparable to that of a savings account, which provides only 4 per cent.
4. Hybrid Investment Funds
Hybrid funds are a combination of equity and debt. These funds typically offer the best of both worlds. These funds are classified into two types based on their use of equity and debt: aggressive hybrid funds and monthly income plans.
These funds are equivalent to balanced funds, but the proportion of equity assets in these funds is lower. As an outcome, they also are referred to as marginal equity funds. They are particularly suited to retired investors seeking a consistent income with low risk.
The equity to financial leverage in the former is 60:40, whereas the ratio in the latter is precisely the opposite, at 40:60; because of the higher equity presence in the aggressive type, the risk level is more elevated, as are the returns.
When comparing equity and debt separately, hybrid funds have a moderate risk and return level overall. These funds are best suited for investors with a time horizon of 2 to 5 years.
Mutual Funds Types Based on Investment Objectives
Funds for growth:
Money is being invested primarily in equity securities in these schemes with the goal of capital appreciation. They are considered risky funds that are best suited for long-term investors. Because they are risky funds, they are also ideal for investors seeking higher returns on investments.
Funds for income:
These schemes invest money mainly in fixed-income tools such as bonds, debentures, and so on to provide shareholders with credit risk management and financial and steady income.
Money is invested mainly in short-term or short-term instruments, such as T-Bills, CPs, and so on, to provide liquidity under these schemes. They are thought to be low risk with moderate returns, making them ideal for shareholders with short-term equity investments.
Capital Preservation Trusts:
These are funds in which the funds are split between investments in fixed income securities and investments in equity markets. This is done to safeguard the principle which has been invested.
Fixed-Maturity Funds (FMFs):
Fixed maturity funds are those where the investments are decided to invest in debt and money market instruments with maturities that are either the same as or earlier than the funds.
Mutual Funds Types Based on Structure
Open-Ended Funds (OEFs):
These are investments in which units can be purchased or redeemed during the year. All purchases and redemptions of these fund units are made at the current NAVs. These funds will allow shareholders to continue investing for as long as they want. The amount of money that can be decided to invest in the fund is not limited.
Closed-End Funds (CEFs):
Units in these funds can only be purchased during the original offer period. Units can be redeemed when they reach a specific maturity date. These schemes are frequently listed for trading on a stock exchange to provide liquidity.
Funds for Intervals:
These are funds that combine the characteristics of open-ended and closed-ended funds in that they are available for share repurchase at various intervals throughout the fund's tenure. During these intervals, the fund management company provides to buy back units from existing unitholders.
Mutual Funds Types Based on Specialty
Mutual Fund Indexes:
Index mutual funds, also recognised as Exchange Traded Funds (ETFs), are a type of mutual fund that tracks and replicates the asset allocation of a particular index. Index mutual funds are typically needed to have an investment strategy of at least 95% compared to the index that it is tracking. Because these funds are managed passively, their expense ratios are also low.
The Fund of Funds:
As the name implies, a Fund of Funds (FoF) invests in those other mutual funds (domestic or international), with the resulting returns on investment varying according to the performance of the target fund. Such investments are thought to be safer than the Fund of Funds.
Mutual Funds for Commodities:
Like sector mutual funds, commodity mutual funds invest in companies that operate in the commodity market. These funds' returns are influenced by the efficiency of the commodity or the supply of the company that manufactures the item. Furthermore, the returns are not cyclical.
Asset Allocation Funds (AAFs):
Allocation of Assets Mutual funds optimises the mix of debt, equity, and, in some cases, gold. These funds are highly adaptable due to the diversification of their asset portfolio. The investment ratio could be determined by current market trends, a predetermined formula, or a fund manager's skill or experience.
The goal of the retirement fund is to provide long-term capital growth and income to build wealth for retirement. The finances are hybrid, with a large portion of the corpus invested in equity for the long term. The funds provide a steady income after retirement through easy withdrawal options.
Mutual Funds Types based on Risks
These are mutual funds for those who do not want to risk their money investing. In such cases, investments are made in the debt market and are typically long-term investments. Because they are low risk, the returns on these investment opportunities are also standard.
These are investments with a medium level of risk for the investor. They are ideal for those willing to take a chance with their investment and typically provide higher returns. These funds could be used as an investor to accumulate wealth over time.
Inverse mutual funds are an example of an increased risk fund. These are mutual funds that are ideal for those willing to take higher risks with one‘s money to build wealth. Even though the risks are high with all these funds, the returns are higher.
How do Mutual Funds operate?
Mutual funds operate by pooling money from a large number of investors. This money is then used to buy stocks, bonds, and other securities. Mutual funds provide instant diversification (and thus lower risk) to investors because they invest in a gathering of companies.
You've probably heard of index funds and exchange-traded funds (ETFs), which are two types of mutual funds that invest passively. However, actively did manage mutual funds exist. Fund managers manage these mutual funds who select investments and buy/sell securities predicated on the fund's objectives.
Actively managed mutual funds typically seek to outperform the market (though consistently outperforming the market over the long term is difficult). In contrast, passive funds index funds, for example, seek to match the market's performance simply. For example, an S& P 500 mutual fund would attempt to replicate the performance of the S& P 500 stock market index by investing in a small proportion of each of the S& P 500 companies.
Mutual Fund Selection Guide - How to Choose One?
Over 44 enrolled fund houses in India have over 2,000 schemes. Although this gives investors more options, the paradox of choice may perplex many. Like any other investment, mutual fund investments are not a game of trial and error. A wrong decision can cost you all of your hard-earned money.
How do you choose the best mutual fund? Occasionally, investors rely on current market trends or seek advice from friends or relatives. You must find a fund that meets your requirements.
Before investing in a mutual fund, consider the following three questions:
1. What is the objective?
Define your financial goal. Clearly defined plans facilitate investment and subsequent tracking. Your objective could be to go on an exotic holiday, save for retirement, or purchase a home. Estimate how much money you'll need to reach your goal and start investing accordingly.
2. How much time do you have available?
Retirement savings are typically long-term investments. You can take more risks if you have a longer investment horizon. Equity mutual funds could be an excellent long-term investment vehicle. If you only have three to five years, your risk capacity will be lower. Debt or hybrid mutual funds may be a better bet for shorter periods.
3. Is your objective negotiable?
Some objectives are not strictly time-bound. For example, you may well be able to postpone purchasing a home for a few years. However, a child's education cannot be jeopardised. If you have a non-negotiable goal, you should consider investing in a low-risk fund.
Mutual fund investing has numerous advantages, including diversification, professionally managed, low price, and a devoted fund manager.Even so, before you engage in some kind of a mutual fund, you must first determine your investment objectives.
An equity fund is best suited to investors with a long investment horizon. Debt mutual funds are beneficial to investors seeking low volatility brief investment options.
Generally, all types of mutual fund schemes, no matter how small, carry some level of risk. As a consequence, you must be cautious as a shareholder read their policy documents before investing. This one small act can provide you with information about the various services offered by the investment company and where your money is invested.
What are the 4 types of mutual funds?
Most mutual funds are classified into one of four types: money market funds, bond funds, stock funds, and aim date funds. Each type has unique characteristics, risks, and rewards.
Money market funds are relatively low-risk investments. They are only permitted by law to invest in certain high-quality, short-term investments.
Bond funds carry higher risks than money markets because they seek higher returns.
Stock fund is a mutual fund which invest in stocks of company stock. Stock funds are not all the same.
Target date funds invest in various stocks, securities, and other assets. The mix gradually changes over time to the fund's strategy.
What are the 3 types of mutual funds?
3 common types of mutual funds
Money market funds.
Fixed income funds.
What are the various types of mutual funds in India?
The various types of mutual funds available can be broadly classified based on structure, investment vehicle, and investment goals.
Few of them are -
Equity or growth schemes.
Money market funds or liquid funds
Fixed income or debt mutual funds
Hybrid / Monthly Income Plans (MIP)
Which is the safest mutual fund in India?
List of the Best Low-Risk Mutual Funds in India, Ranked by 5-Year Returns
Quant Multi-Asset Fund. ...
ICICI Prudential Equity & Debt Fund. ...
ICICI Prudential Multi-Asset Fund. ...
Baroda BNP Paribas Aggressive Hybrid Fund. ...
Edelweiss Aggressive Hybrid Fund. ...
Canara Robeco Equity Hybrid Fund. ...
Mirae Asset Hybrid Equity Fund.
How many types of mutual funds are there in India?
There are currently over 44 authorised mutual funds in India, each offering a different scheme to meet the changing needs of diverse investors. The various types of mutual funds available can be broadly classified based on structure, asset class, and investment goals.