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Types of mutual funds and how to start investing in them

04 April 2016
While investing in mutual funds is a smart decision, proceeding without proper understanding of the various types of mutual fund products is not advisable. Gilt funds, ELSS, Treasury Bill funds—explore the various options at your disposal before deploying your hard-earned money into your investments.

A mutual fund is an investment vehicle that enables individuals to invest in various asset classes like equity, debt, money market, and even international markets, with comparatively lower risk and greater flexibility.

With so many options available in the market, however, it can be confusing to pick a suitable type of mutual fund as per your financial situation. To help you take an informed decision, we describe below the various types of mutual funds, based on certain criteria that differentiates them:

Subscription and maturity period

  • Open-ended funds can be subscribed or bought from the mutual fund company and sold or redeemed to the company as and when you want.
  • Closed-endedfunds can be subscribed and redeemed only when allowed by the issuer.
  • Interval funds are open for subscription and redemption at multiple intervals, which means these funds combine the features of open and closed-ended funds.

Risk profile

  • Debt funds invest in ultra-safe government securities, bonds, debentures, highly-liquid money market instruments, and other low-risk securities offering steady moderate returns with minimal risk of loss of capital.
  • Equity funds invest more than 65% of its corpus in shares and stocks of different companies. In terms of risk profile, these funds are the riskiest while funds investing in gilt securities are the safest.
  • Balanced funds are ideal for those with a slightly higher tolerance to the risk of losses. As the name suggests, these funds invest in a balanced portfolio consisting of debt instruments offering fixed income as well as riskier equity asset classes offering higher returns.

Related:Simple ways to achieve a diversified financial portfolio

Asset class

In terms of asset class, mutual funds can be classified into equity, debt, money market, and balanced funds.

The different types of equity funds include:

  1. Sectoral funds that invest in specific sectors like Auto, Pharma, or Capital Goods. An individual with limited capital seeking to invest in Pharma companies like Lupin, Aurobindo Pharma, and Dr. Reddys can do so by buying units of a Pharma sector fund. The Pharma sector offered returns of 9.06% in 2014-15 as opposed to 0.41% returns by the benchmark CNX Nifty index. A sectoral fund investment can help individuals earn good returns even when the overall market sentiment is subdued.
  2. Index funds invest in companies that constitute stock exchange indexes like the CNX Nifty, the Bank Nifty, and BSE 500 and so on. The CNX Nifty consists of 50 companies spread over 13 sectors. Buying units for a Nifty Fund will be a lot easier than individually buying shares of all Nifty companies.
  3. Capitalization-specific funds will invest in either only small-cap, mid-cap, or large-cap companies depending on the investment objectives of the fund. If a small cap company grows into a mid-cap one, then the fund will divest its investments and reinvest the same in other small-cap companies.
  4. Diversified funds combine the features of the above-mentioned funds and invest the corpus in different companies depending on risk tolerance and profit objective of the fund managers. Such funds can help investors combine blue-chip safe options like ONGC and TCS with lesser-known companies that may offer very high returns on the investment.
  5. ELSS funds are equity-linked saving schemes that offer the twin benefits of low-risk participation in the equity market and tax savings, which is otherwise not available to other mutual fund investors.

Related: What to know about Equity Linked Savings Scheme Mutual Funds Part I

Debt funds too can be classified into the following types:

  1. Gilt funds, as the name suggests, invest solely in government securities. In terms of risks, these funds offer the safest option for investors to generate moderate returns on excess cash.
  2. Bond funds often invest in a combination of government bonds, corporate securities and debentures, and money-market instruments. These mutual funds may invest in ultra-short term instruments like Treasury Bills, short-term bonds, long-term debentures, or a mix of the above options.
  3. Money market funds invest in highly-liquid ultra-short term instruments like Treasury Bills. These funds are designed for individuals and companies seeking to invest surplus funds for moderate returns without the risk of loss of liquidity.
  4. Balanced funds invest in some or all the above-mentioned asset classes. Such a fund may allocate a part of its corpus towards equity shares, another part into gilt funds, and the rest into long-term debentures or short-term money market securities.

Related:Give yourself the gift of compounding

How to begin to invest in mutual funds

For ordinary investors, the easiest way to start investing in mutual funds is to opt for Systematic Investment Plans. This option allows you start investing as little as Rs. 5,000 in a systematic manner on a monthly, quarterly, or half-yearly basis.

It is important to choose a fund from a reputed brand with high value of Assets under Management that offers different types of mutual fund products depending on your investment objective, risk tolerance, and availability for surplus cash for investment purposes.

If there’s anything else you want to know about Mutual Funds, leave it in the comments below.

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