- Date : 18/10/2020
- Read: 7 mins
Mutual funds have attracted a lot of attention in recent years. What makes them so popular? Read on to know the benefits of different mutual funds and how they work.
Owing to their inbuilt diversity and ease of use, mutual funds are one of the most popular investment options for Indians today. These investments are designed to spread risk while allowing the investor to capture wider market gains. A type of financial vehicle that is operated by expert money managers usually consists of a portfolio of stocks, bonds, securities, and other market instruments.
If you are looking for the best mutual funds to invest in, this quick guide will help you make a more informed decision. Without further ado, let us look at the different types of mutual funds one can invest in.
Equity mutual funds or growth funds invest in the stocks/shares of a company. One of the most sought after mutual funds, they offer high returns despite being categorised as high-risk. These funds are ideal for young but experienced investors who are in their prime earning stage. With the right appetite for risk, one can build a diverse portfolio with different equity funds such as growth stocks, income funds, value funds, and large-, mid-, and small-cap stocks.
When investing in an equity fund, ensure that your decision is in sync with your risk profile. Equity funds are recommended for those with a long-term goal (five years or more) since it allows the fund to grow even in the face of market fluctuations.
Related: How to choose an equity mutual fund
Fixed-income funds are debt funds that invest in government bonds and corporate bonds. In this type of mutual fund, investors build a portfolio based on the interest rates received on their initial investment. A change in interest rate impacts the fund, so these are best suited for investors with low risk appetite who intend to invest with a long-term plan in mind.
Debt mutual funds focus on generating income rather than wealth and are considered a reliable source of income for investors. They are a safer investment than stocks but have a lower potential for growth than do equity funds. To know how to choose between fixed-income and market-linked investment avenues, click here.
Money market funds
Money market funds are an ideal investment for those who have lower risk tolerance. These funds invest in short-term debt instruments such as government bonds, treasury bills, and other cash equivalents. With an average maturity period of one year, the sole purpose of an MMF is to help an investor earn interest by minimising the fluctuations of the Net Asset Value (NAV) of the fund.
Those with a low appetite for risk and surplus cash in a savings account should consider investing in money market mutual funds. They offer a good short-term income by diversifying one’s portfolio with different money market instruments.
Just as the name suggests, balanced funds or hybrid mutual funds offer investors exposure to both equity and debt investment. The aim behind investing in a balanced fund is to balance the risk-to-reward ratio. Since these funds are not entirely risk-free, investors should ideally have a strategic mix of debt with equity instruments to make the fund less vulnerable to market fluctuations. Balanced funds are a good option for investors who seek maximum capital gain with minimal risks. To read in detail about hybrid funds, click here.
These are some of the many mutual funds available in India today. With so many investment options in the market, how does one choose what’s best? The simplest way is to first identify your goal and determine your risk appetite. Read the investment documents carefully – consult a professional if you think it will help – to understand the fine print involved.
Find out how and why Savvy millennials are betting big on mutual funds.
STRUCTURED MUTUAL FUNDS
Open-ended mutual funds are an investment scheme that involves pooling in money from investors for a variety of underlying investment securities. There is no constraint on a specific period or the number of units that can be traded. Profits and losses are shared by investors in equal proportion to their investments. Since there are no restrictions on the investor to redeem the units in an open-ended mutual fund, they have more access to liquidity and earn higher returns in the long run.
These funds are best suited for investors looking for easy access to liquidity or those looking to diversify their investment portfolio.
Closed-ended mutual funds are a kind of equity or debt funds where the fund house issues a fixed number of units. The fund company cannot sell more than the pre-agreed number of units, making closed-ended mutual funds a stable asset for managers to work with. Closed-ended mutual funds require a lump sum investment and offer no redemption options until maturity.
These funds are best for investors with a sizeable investible corpus and a sense of asset allocation across different funds.
With traits of both open-ended and closed-ended mutual funds, interval funds allow investors the freedom to purchase or sell units only during a pre-decided time. Your money will remain invested for the fixed tenure and cannot be redeemed before maturity. These funds are suitable for investors looking to achieve a short-term goal, or for those who lack clarity about their investment tenure.
INVESTMENT-DRIVEN MUTUAL FUNDS
Growth funds are usually a diversified portfolio of stocks where you can allocate a considerable portion in shares and growth sectors. These funds are suitable for young or middle-aged investors who have surplus idle money lying around.
Income mutual funds or exchange-traded funds (ETFs) are a type of debt mutual funds that invest in corporate bonds, government bonds, and money market instruments. Since the emphasis is on capital protection, these funds are best suited for risk-averse investors. Read this - Mutual Funds: Growth option vs Dividend option. Which should you opt for?
Belonging to the debt fund category, liquid funds primarily invest in financial instruments like treasury bills, commercial papers, fixed deposits, and other forms of debt securities. These short-term investments come with a maturity period of 91 days and are the safest of all the mutual fund categories. These are perfect to meet short-term investment needs or emergencies. Why keep money in a savings account when you can invest in these liquid mutual funds?
Tax saver or Equity Linked Saving Scheme (ELSS) mutual funds help you save tax under Section 80C and create long-term wealth. They also have the lowest lock-in period (3 years) and are best suited for salaried investors with a long-term investment goal. To know in detail about ELSS, read this - Equity Linked Savings Schemes: High returns + tax savings (Part I)
SPECIALISED MUTUAL FUNDS
Sector funds are an equity scheme that invests solely in shares of companies in a specific sector. With only a few stocks to invest in, the risk factor with this type of investment is on the higher side. If, as an investor, you track sector-related trends, you can enjoy great returns. Sectors like banking, IT, and pharma have witnessed consistent growth and have a promising future.
Index mutual funds imitate a stock market index by investing in stocks. These funds purchase stocks in the same proportion as in an index. Best suited for passive investors, index funds are less risky as compared to other funds and provide broad market exposure to investors.
Emerging market funds
Emerging market funds are a type of mutual fund or ETF that invests in stocks of developing countries. It focuses on the entire spectrum of the stocks of countries undergoing economic transition. Developing nations like India, China, Russia, and Brazil are expected to contribute to global growth in the coming years. Look at these 5 Ways in which mutual funds improve your finances.