If you are thinking of diversifying your investments, there are various types of mutual fund options that you can opt for. They can be categorised based on various characteristics like asset class, investment goals and risk.
In the article below, learn about the different types of mutual funds and the benefits that they offer.
Types of Mutual Funds
Considering investing in Mutual Funds? Then it is of utmost importance to understand the various mutual fund types and the benefits they offer. Mutual fund types can be classified based on various characteristics. Learn more about different mutual fund types below:
- Equity Funds
- Debt Funds
- Money Market Funds
- Hybrid Funds
- Growth Funds
- Income Funds
- Liquid Funds
- Tax-Saving Funds
- Aggressive Growth Funds
- Capital Protection Funds
- Fixed Maturity Funds
- Pension Funds
Based on Asset Class
The classification of mutual funds based on asset class is as follows:
Equity funds primarily invest in stocks, and hence go by the name of stock funds as well. They invest the money pooled in from various investors from diverse backgrounds into shares/stocks of different companies. The gains and losses associated with these funds depend solely on how the invested shares perform (price-hikes or price-drops) in the stock market. Also, equity funds have the potential to generate significant returns over a period. Hence, the risk associated with these funds also tends to be comparatively higher.
Debt funds invest primarily in fixed-income securities such as bonds, securities and treasury bills. They invest in various fixed income instruments such as Fixed Maturity Plans (FMPs), Gilt Funds, Liquid Funds, Short-Term Plans, Long-Term Bonds and Monthly Income Plans, among others. Since the investments come with a fixed interest rate and maturity date, it can be a great option for passive investors looking for regular income (interest and capital appreciation) with minimal risks.
Money Market Funds
Investors trade stocks in the stock market. In the same way, investors also invest in the money market, also known as capital market or cash market. The government runs it in association with banks, financial institutions and other corporations by issuing money market securities like bonds, T-bills, dated securities and certificates of deposits, among others. The fund manager invests your money and disburses regular dividends in return. Opting for a short-term plan (not more than 13 months) can lower the risk of investment considerably on such funds.
As the name suggests, hybrid funds (Balanced Funds) is an optimum mix of bonds and stocks, thereby bridging the gap between equity funds and debt funds. The ratio can either be variable or fixed. In short, it takes the best of two mutual funds by distributing, say, 60% of assets in stocks and the rest in bonds or vice versa. Hybrid funds are suitable for investors looking to take more risks for ‘debt plus returns’ benefit rather than sticking to lower but steady income schemes.
Based on Investment Goals
Here are the different types of mutual funds based on investment goals:
Growth funds usually allocate a considerable portion in shares and growth sectors, suitable for investors (mostly Millennials) who have a surplus of idle money to be distributed in riskier plans (albeit with possibly high returns) or are positive about the scheme.
Income funds belong to the family of debt mutual funds that distribute their money in a mix of bonds, certificate of deposits and securities among others. Helmed by skilled fund managers who keep the portfolio in tandem with the rate fluctuations without compromising on the portfolio’s creditworthiness, income funds have historically earned investors better returns than deposits. They are best suited for risk-averse investors with a 2-3 years perspective.
Like income funds, liquid funds also belong to the debt fund category as they invest in debt instruments and money market with a tenure of up to 91 days. The maximum sum allowed to invest is Rs 10 lakh. A highlighting feature that differentiates liquid funds from other debt funds is the way the Net Asset Value is calculated. The NAV of liquid funds is calculated for 365 days (including Sundays) while for others, only business days are considered.
ELSS or Equity Linked Saving Scheme, over the years, have climbed up the ranks among all categories of investors. Not only do they offer the benefit of wealth maximisation while allowing you to save on taxes, but they also come with the lowest lock-in period of only three years. Investing predominantly in equity (and related products), they are known to generate non-taxed returns in the range 14-16%. These funds are best-suited for salaried investors with a long-term investment horizon.
Aggressive Growth Funds
Slightly on the riskier side when choosing where to invest in, the Aggressive Growth Fund is designed to make steep monetary gains. Though susceptible to market volatility, one can decide on the fund as per the beta (the tool to gauge the fund’s movement in comparison with the market). Example, if the market shows a beta of 1, an aggressive growth fund will reflect a higher beta, say, 1.10 or above.
Capital Protection Funds
If protecting the principal is the priority, Capital Protection Funds serves the purpose while earning relatively smaller returns (12% at best). The fund manager invests a portion of the money in bonds or Certificates of Deposits and the rest towards equities. Though the probability of incurring any loss is quite low, it is advised to stay invested for at least three years (closed-ended) to safeguard your money, and also the returns are taxable.
Fixed Maturity Funds
Many investors choose to invest towards the of the FY ends to take advantage of triple indexation, thereby bringing down tax burden. If uncomfortable with the debt market trends and related risks, Fixed Maturity Plans (FMP) – which invest in bonds, securities, money market etc. – present a great opportunity. As a close-ended plan, FMP functions on a fixed maturity period, which could range from one month to five years (like FDs). The fund manager ensures that the money is allocated to an investment with the same tenure, to reap accrual interest at the time of FMP maturity.
Putting away a portion of your income in a chosen pension fund to accrue over a long period to secure you and your family’s financial future after retiring from regular employment can take care of most contingencies (like a medical emergency or children’s wedding). Relying solely on savings to get through your golden years is not recommended as savings (no matter how big) get used up. EPF is an example, but there are many lucrative schemes offered by banks, insurance firms etc.
Based on Structure
Mutual funds are also categorised based on different attributes (like risk profile, asset class, etc.). The structural classification – open-ended funds, close-ended funds, and interval funds – is quite broad, and the differentiation primarily depends on the flexibility to purchase and sell the individual mutual fund units.
Open-ended funds do not have any particular constraint such as a specific period or the number of units which can be traded. These funds allow investors to trade funds at their convenience and exit when required at the prevailing NAV (Net Asset Value). This is the sole reason why the unit capital continually changes with new entries and exits. An open-ended fund can also decide to stop taking in new investors if they do not want to (or cannot manage significant funds).
In closed-ended funds, the unit capital to invest is pre-defined. Meaning the fund company cannot sell more than the pre-agreed number of units. Some funds also come with a New Fund Offer (NFO) period; wherein there is a deadline to buy units. NFOs comes with a pre-defined maturity tenure with fund managers open to any fund size. Hence, SEBI has mandated that investors be given the option to either repurchase option or list the funds on stock exchanges to exit the schemes.
Interval funds have traits of both open-ended and closed-ended funds. These funds are open for purchase or redemption only during specific intervals (decided by the fund house) and closed the rest of the time. Also, no transactions will be permitted for at least two years. These funds are suitable for investors looking to save a lump sum amount for a short-term financial goal, say, in 3-12 months.
Based on Risk
The mutual fund types based on risk are:
Very Low-Risk Funds
Liquid funds and ultra-short-term funds (one month to one year) are known for its low risk, and understandably their returns are also low (6% at best). Investors choose this to fulfil their short-term financial goals and to keep their money safe through these funds.
In the event of rupee depreciation or unexpected national crisis, investors are unsure about investing in riskier funds. In such cases, fund managers recommend putting money in either one or a combination of liquid, ultra short-term or arbitrage funds. Returns could be 6-8%, but the investors are free to switch when valuations become more stable.
Here, the risk factor is of medium level as the fund manager invests a portion in debt and the rest in equity funds. The NAV is not that volatile, and the average returns could be 9-12%.
Suitable for investors with no risk aversion and aiming for huge returns in the form of interest and dividends, high-risk mutual funds need active fund management. Regular performance reviews are mandatory as they are susceptible to market volatility. You can expect 15% returns, though most high-risk funds generally provide up to 20% returns.
Specialized Mutual Funds
These mutual funds are based on specific industries:
Sector funds invest solely in one specific sector, theme-based mutual funds. As these funds invest only in specific sectors with only a few stocks, the risk factor is on the higher side. Investors are advised to keep track of the various sector-related trends. Sector funds also deliver great returns. Some areas of banking, IT and pharma have witnessed huge and consistent growth in the recent past and are predicted to be promising in future as well.
Suited best for passive investors, index funds put money in an index. A fund manager does not manage it. An index fund identifies stocks and their corresponding ratio in the market index and put the money in similar proportion in similar stocks. Even if they cannot outdo the market (which is the reason why they are not popular in India), they play it safe by mimicking the index performance.
Funds of Funds
A diversified mutual fund investment portfolio offers a slew of benefits, and ‘Funds of Funds’ also known as multi-manager mutual funds are made to exploit this to the tilt – by putting their money in diverse fund categories. In short, buying one fund that invests in many funds rather than investing in several achieves diversification while keeping the cost down at the same time.
Emerging market Funds
To invest in developing markets is considered a risky bet, and it has undergone negative returns too. India, in itself, is a dynamic and emerging market where investors earn high returns from the domestic stock market. Like all markets, they are also prone to market fluctuations. Also, from a longer-term perspective, emerging economies are expected to contribute to the majority of global growth in the following decades.
International/ Foreign Funds
Favoured by investors looking to spread their investment to other countries, foreign mutual funds can get investors good returns even when the Indian Stock Markets perform well. An investor can employ a hybrid approach (say, 60% in domestic equities and the rest in overseas funds) or a feeder approach (getting local funds to place them in foreign stocks) or a theme-based allocation (e.g., gold mining).
Aside from the same lexical meaning, global funds are quite different from International Funds. While a global fund chiefly invests in markets worldwide, it also includes investment in your home country. The International Funds concentrate solely on foreign markets. Diverse and universal in approach, global funds can be quite risky to owing to different policies, market and currency variations, though it does work as a break against inflation and long-term returns have been historically high.
Real Estate Funds
Despite the real estate boom in India, many investors are still hesitant to invest in such projects due to its multiple risks. Real estate fund can be a perfect alternative as the investor will be an indirect participant by putting their money in established real estate companies/trusts rather than projects. A long-term investment negates risks and legal hassles when it comes to purchasing a property as well as provide liquidity to some extent.
Commodity-focused Stock Funds
These funds are ideal for investors with sufficient risk-appetite and looking to diversify their portfolio. Commodity-focused stock funds give a chance to dabble in multiple and diverse trades. Returns, however, may not be periodic and are either based on the performance of the stock company or the commodity itself. Gold is the only commodity in which mutual funds can invest directly in India. The rest purchase fund units or shares from commodity businesses.
Market Neutral Funds
For investors seeking protection from unfavourable market tendencies while sustaining good returns, market-neutral funds meet the purpose (like a hedge fund). With better risk-adaptability, these funds give high returns where even small investors can outstrip the market without stretching the portfolio limits.
While a regular index fund moves in tandem with the benchmark index, the returns of an inverse index fund shift in the opposite direction. It is nothing but selling your shares when the stock goes down, only to repurchase them at an even lesser cost (to hold until the price goes up again).
Asset Allocation Funds
Combining debt, equity and even gold in an optimum ratio, this is a greatly flexible fund. Based on a pre-set formula or fund manager’s inferences based on the current market trends, asset allocation funds can regulate the equity-debt distribution. It is almost like hybrid funds but requires great expertise in choosing and allocation of the bonds and stocks from the fund manager.
Yes, you can also gift a mutual fund or a SIP to your loved ones to secure their financial future.
It belongs to the index funds family and is bought and sold on exchanges. Exchange-traded Funds have unlocked a new world of investment prospects, enabling investors to gain extensive exposure to stock markets abroad as well as specialised sectors. An ETF is like a mutual fund that can be traded in real-time at a price that may rise or fall many times in a day.
As a tax-paying citizen, Section-80C of the Indian Tax Act allows you some breather – a deduction of up to 150,000 from your total annual income.
FAQs (Frequently asked Questions)
What is a mutual fund portfolio?
The combined holdings of a fund scheme consisting of securities like short-term debt, stocks, bonds, etc., is called a mutual fund portfolio.
How does an investor buy and sell mutual funds?
An investor can purchase shares of mutual funds from the Asset Management Company or via a broker for the fund.
When can I start investing in mutual funds?
The minimum age for investing in mutual funds in India is 18 years. So, you can start investing in mutual fund schemes as soon as you start earning and saving.
Does an individual need a PAN card to invest in mutual funds?
Yes, it is mandatory to have a PAN card for mutual fund investment.
What is the NAV of a mutual fund?
The Net Asset Value (NAV) is the market price of all the securities that a mutual fund scheme currently holds.
Are debt funds free of risk?
No, debt funds are not free of risk. However, they are less risky if you compare them to equity funds as they do not invest in equities.
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Now, let's delve into the concepts discussed in the article:
- Invest primarily in stocks, offering the potential for significant returns but with higher associated risks.
- Invest in fixed-income securities like bonds and treasury bills, providing regular income with comparatively lower risk.
Money Market Funds:
- Invest in short-term money market instruments, providing regular dividends with lower risk.
- Blend of stocks and bonds, balancing risk and returns for investors seeking a middle ground.
- Allocate a considerable portion to growth sectors, suitable for investors seeking potentially high returns in riskier plans.
- Belong to debt mutual funds, distributing money in a mix of bonds and securities, suitable for risk-averse investors.
- Belong to debt funds, investing in debt instruments and money markets with a short tenure.
Tax-Saving Funds (ELSS):
- Invest predominantly in equity, offering tax benefits with a relatively short lock-in period.
Aggressive Growth Funds:
- Designed for steep monetary gains, with higher risk and returns.
Capital Protection Funds:
- Aim to protect the principal while earning relatively smaller returns, suitable for risk-averse investors.
Fixed Maturity Funds (FMP):
- Close-ended plans investing in bonds, securities, and money markets with a fixed maturity period.
- Long-term investment to secure financial future after retirement.
- No specific constraints on trading, allowing investors to enter and exit at their convenience.
- Pre-defined unit capital, with a fixed number of units available for sale, often with a specific maturity tenure.
- Open for purchase or redemption only during specific intervals, combining traits of both open-ended and closed-ended funds.
- Very Low-Risk, Low-Risk, Medium-Risk, High-Risk funds based on the risk level and potential returns.
Specialized Mutual Funds:
- Sector Funds, Index Funds, Funds of Funds, Emerging Market Funds, International/Foreign Funds, Global Funds, Real Estate Funds, Commodity-focused Stock Funds, Market Neutral Funds, Inverse/Leveraged Funds, Asset Allocation Funds, Gift Funds, and Exchange-Traded Funds.
- Definitions and explanations regarding mutual fund portfolios, buying and selling processes, minimum age for investing, the necessity of a PAN card, and the concept of Net Asset Value (NAV).
This comprehensive overview provides a solid foundation for understanding the diverse landscape of mutual funds and their classifications, catering to a wide range of investor preferences and risk appetites.