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Before understanding the types of Mutual Funds, let’s understand –
What are Mutual Funds?
Mutual Fund is an avenue where people who share a common investment objective pool in their money with the intention of earning returns. Mutual Fund Companies issue units to the investors and invest the pooled funds in securities according to the objectives of the investors.
When it comes to investing there is a famous quote that says:
“Never put all your eggs in one basket.“Miguel Cervantes
The meaning of this quote is Diversification. And Mutual Funds are an investment avenue that provides a significant way to diversify your portfolio.
There are a number of investors with different risk appetites and the time horizon of their investment, who would be willing to invest in funds that will suit their interest and objective. And you are at the right place as by the end of this article you would have a good idea as to in which fund you should be parking your funds.
Now let us look into the types of Funds Available:
Based on Time Interval:
You as an investor can select the funds based on the time you want to stay invested. The different types of Mutual Funds based on Time Intervals are :
#1 Open-Ended Funds:
From the name of the fund itself we can understand that Open-Ended Funds have no certain time as in, the investors can enter and exit the fund at any time according to their choice. There are no restrictions on the no. of units that can be traded.
#2 Closed-Ended Funds:
Here unlike Open-Ended Funds, Closed Ended Funds do have a fixed maturity. The investors cannot exit/redeem the units before maturity unless the fund is listed in a stock exchange or the fund house allows the investor to sell the units to the Fund House through the periodic repurchase of the units. Also, the unit capital to invest in is pre-defined.
#3 Interval Fund
Interval Funds are basically a mix of both Open-Ended and Closed-Ended Funds, which means that the fund can be purchased or redeemed only at intervals and are closed for the rest of the time.
Based on Asset Class:
Asset class refers to the financial instruments the Fund will be investing in. The Mutual Fund can be divided on the basis of the Instruments/Assets they invest in. The types are as follows:
#1 Equity Funds:
As the name suggests Equity Funds invest in the shares of different companies. The amount of return generated by the fund depends on the way these companies perform. The equity fund has the capability to give significant returns and hence also has a higher risk. It is more suitable for those investors who have a high-risk appetite.
An example of an Equity Fund is Mirae Asset Emerging Bluechip Fund whose past 3-year return has been 16.09% approximately.
#2 Debt Funds:
Debt Funds generally invest in Fixed Income Avenues such as Bonds, Government Securities, Money Market Instruments, and Corporate Debentures. Unlike Equity Funds, Debt funds generate a fixed income and so it has comparatively lesser risk associated with it. So those people who want a stable return with less risk, this is the investment avenue for you.
#3 Money Market Funds:
There might be certain investors who would be willing to invest for a shorter period of time say for 1 year or less than, this is the fund they are looking for. This fund specifically invests in avenues like Bonds, Treasury Bills, Dated Securities, and Certificate of Deposit(COD) for a shorter period of the term. Since the term of investment is small so is the risk involved in this fund.
#4 Hybrid Fund:
An investor with an aim to attain stability in the returns and to appreciate the Capital? This is the fund you should be looking for. Hybrid Funds invest in both Equities and Debt instruments.
An investor can decide the proportion of the amount that he wishes to be invested in equities and debts according to his investment plan (say 80% of capital in equity and 20% of capital in debt). These funds are generally less risky than Equity Fund and contain more risk than Debt Funds.
#5 Gilt Funds:
As the name suggests, Gilt Funds are those mutual funds whose interests lie in Government Securities. And it is known that when Government-backed Security is involved, the chances of default are considered negligible i.e. Zero Default Risk.
Well, there are two sides of a coin right! So, on the downside, these funds are very reactive to the Interest Rate, which means that they have a very high interest rate risk.
You must be confused as to how the interest rate can affect Gilt Funds? Let me clear it out… Government Securities are like a savings account where you put in your money and earn interest on it. Now, when the RBI reduces the interest rate, the demand for the Government Securities that were issued earlier rises because they carry higher interest rates than banks whereas, when RBI starts increasing rates the opposite happens as the new bonds that will be issued would have high-interest rates and so the demand of the bonds issued earlier would fall. And so will their prices.
Therefore, only those investors having a greater degree of knowledge on the changes of interest rate should invest in these funds.
#1 Tax Saving ELSS (Equity Linked Savings Scheme) Funds:
Best Way To Save Tax? It is a scheme where individuals and HUF are allowed a deduction of up to 1.5 Lakhs under Section 80C of the Income Tax Act 1961. It invests in equities and is preferable for investors with a moderately high-risk appetite. These Funds have a lock-in period of 3 years which means that for 3 years the funds cannot be redeemed, after this period it is free to be redeemed. For example, let’s say you have invested Rs 70,000 and have invested in this tax-saving fund, then this amount would be deducted from your annual taxable income as this amount is less than 1.5Lakhs.
#2 Index Funds:
Let’s understand the meaning of Index first, It can be termed as a benchmark of Stock Market, Didn’t get it? As the thermometer is used to measure our body temperature, similarly, the Index measures the temperature of the market. The main Indexes of the Indian Stock market are the Nifty 50 and Sensex.
Now since you understood the meaning of Index, let’s come back to our topic of Index Funds. The performance of these funds is linked to the performance of the Index. So, the return of these funds would be more or less similar to that of the Index.
#3 Sector Specific Fund:
The best example to explain the Sector-Specific Fund is the ongoing Covid situation in India. Everyone knows that the only sector that is performing extremely well during this ongoing situation is Pharma Sector. How about you get an opportunity to invest in each pharma company listed in the exchange under one single fund, wouldn’t that be amazing? These type of Funds invests in a particular sector, for example, BANKS, FMCG, PHARMA, etc.
Now since it invests only in a specific sector, so the returns of the fund are directly linked with the performance of that particular sector which makes it a riskier avenue to park your funds. As a piece of single negative news about that particular sector and you would start losing your money.
#4 Real Estate Fund:
Most of us are aware of what Real estate means, those who are not aware, in simple terms it means property like Land, Building, etc. For most of small investors buying properties can be expensive, but think of an avenue in which you can invest in real estate companies rather than having to purchase one. These funds invest in real estate companies/ trusts. Based on practical experience (buying properties) we have seen that to earn significant returns it would be good if we hold Real estate funds for the longer term. Real Estate Fund has certain benefits over purchasing properties physically i.e. greater amount of liquidity, avoiding the risks, and all the legal formalities that used to be so problematic when buying a project.
#5 Exchange-Traded Funds (ETF):
It is like a Mutual Fund that trades as stocks do i.e. at a price that may rise and fall several times during the day. They are traded in exchanges like National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) in India. ETFs are more like the security that can be bought and sold on the stock exchange. Some of the ETFs in India are HDFC Sensex ETF, SBI- ETF Sensex, and so on.
#6 Foreign Funds:
These Funds give the investor exposure to foreign securities. Diversification is the key to great returns. The main reason investors diversify is to keep their portfolio stable even if the Indian stock market does not perform well and can take advantage of the foreign securities’ performance. In these funds, the investor can decide the proportion of the investments same as of hybrid fund. For example, the investor can decide that he wants to keep 70% of his fund in Indian Securities and the rest 30% in Foreign Securities.
#7 Liquid Funds:
It belongs to the Debt Family (invests in Treasury Bills, Commercial Paper, Certificate of Deposit, etc.) i.e. these funds also invest in debt instruments, but for a shorter period which is up to 91 days. The amount of investment is also fixed to 10 Lakhs. Liquid funds are highly liquid(i.e. the assets can get converted into cash real quick) and less risky. Those investors who are conservative and want to just park funds should look for this for the time being. It is a better option than keeping your money in Bank Savings Account/ Fixed Deposit as it provides a higher return than those avenues.
#8 Fund of Funds:
There might be investors who might want to enjoy the benefit of a variety of funds under a single instrument and not having to invest in all the funds separately, then this is the Fund you are looking for. These funds invest in a variety of Mutual Funds rather than investing in different investment instruments and so it has the advantage of lower cost. This is the reason why it is termed as Fund of Funds. SBI Gold Fund is one of the Fund of Funds in India.
#9 Gift Funds:
If I was asked what I wanted as a Birthday Gift, my answer would be “Gift me a Mutual Fund” Sounds Funny, right? But yes we can gift Mutual Funds to our loved ones. Like why ask for a gift that depreciates over time rather than asking for a gift that appreciates with time and creates wealth for you. So next time when you are asked what present you want, be smart.
#10 Growth Fund:
It Belongs to the Equity Fund Family. These funds invest mostly in shares and growth sectors. It consists of the companies whose growth has been quite attractive, that focuses on reinvesting their earnings into the expansion of its business rather than paying huge dividends. They either pay very less dividends or no dividends at all. They provide great potential for the appreciation of capital.
And it is known that high returns mean higher risk. Growth Funds are generally riskier and are more suitable to investors who are in their early age of life and have a high-risk appetite.
So as I said, Mutual Fund is the best way to diversify your portfolio as there are plenty of schemes available where you can invest according to your own traits and goals. Equity Funds are most suited to the investors who are in their early years of life as they would have a higher risk capacity than those of higher age groups. Debt funds are suitable for the investors who want a fixed income and do not want to take much risk i.e. mostly higher age groups like people after retirement prefer these funds. There are plenty of Mutual Fund Schemes in India that you can choose from.
Knowing yourself as an investor is very important before getting into any Mutual Fund as if you invest your money in the wrong fund you might not get the expected returns in the expected time. Also before investing, check the fund’s past performances as it is said that in markets” History repeats itself”.