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Types of Mutual Funds

Mutual funds in India are broadly classified into equity funds, debt funds, and balanced mutual funds, depending on their asset allocation and equity exposure. Therefore, the risk assumed and returns provided by a mutual fund plan would depend on its type. We have broken down the types of mutual funds in detail below:

1. Equity funds, as the name suggests, invest mostly in equity shares of companies across all market capitalizations. A mutual fund is categorized under equity fund if it invests at least 65% of its portfolio in equity instruments. Equity funds have the potential to offer the highest returns among all classes of mutual funds. The returns provided by equity funds depend on the market movements, which are influenced by several geopolitical and economic factors. The equity funds are further classified as below:

   1. Small-Cap Funds

      Small-cap funds are those equity funds that predominantly invest in equity and equity-linked instruments of companies with small market capitalization. SEBI defines small-cap companies as those that are ranked after 251 in market capitalization.

   2. Mid-Cap Funds

      Mid-cap funds are those equity funds that invest primarily in equity and equity-linked instruments of companies with medium market capitalization. SEBI defines mid-cap companies as those that are ranked between 101 and 250 in market capitalization.

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      1. Large-Cap Funds

         Large-cap funds are those equity funds that invest mostly in equity and equity-linked instruments of companies with large market capitalization. SEBI defines large-cap companies as those that are ranked between 1 and 100 in market capitalization.

      2. Multi-Cap Funds

         Multi-Cap Funds invest substantially in equity and equity-linked instruments of companies across all market capitalizations. The fund manager would change the asset allocation depending on the market condition to reap the maximum returns for investors and reduce the risk levels.

      3. Sector or Thematic Funds

         Sectoral funds invest principally in equity and equity-linked instruments of companies in a particular sector like FMCG and IT. Thematic funds invest in equities of companies that operate with a similar theme like travel.

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         1. Index Funds

            Index Funds are a type of equity fund having the intention of tracking and emulating the performance of a popular stock market index such as the S&P BSE Sensex and NSE Nifty50. The asset allocation of an index fund would be the same as that of its underlying index. Therefore, the returns offered by index mutual funds would be similar to that of its underlying index.

         2. ELSE

            An equity-linked savings scheme (ELSS) is the only kind of mutual fund covered under Section 80C of the Income Tax Act, 1961. Investors can claim tax deductions of up to Rs 1,50,000 a year by investing in ELSS.

2. Debt Mutual Funds

   Debt mutual funds invest mostly in debt, money market, and other fixed-income instruments such as treasury bills, government bonds, certificates of deposit, and other high-rated securities. A mutual fund is considered a debt fund if it invests a minimum of 65% of its portfolio in debt securities. Debt funds are ideal for risk-averse investors as the performance of debt funds is not influenced much by market fluctuations. Therefore, the returns provided by debt funds are very much predictable. The debt funds are further classified as below:

   1. Dynamic Bond Funds

      Dynamic Bond Funds are those debt funds whose portfolio is modified depending on the fluctuations in the interest rates.

   2. Income Funds

      Income Funds invest in securities that come with a long maturity period and therefore, provide stable returns over time. The average maturity period of these funds is five years.

   3. Short-Term and Ultra Short-Term Debt Funds

      Short-term and ultra short-term debt funds are those mutual funds that invest in securities that mature in one to three years. These funds are ideal for risk-averse investors.

   4. Liquid Funds

      Liquid funds are debt funds that invest in assets and securities that mature within ninety-one days. These mutual funds generally invest in high-rated instruments. Liquid funds are a great option to park your surplus funds, and they offer higher returns than a regular savings bank account.

   5. Gilt Funds

      Gilt Funds are debt funds that invest in high-rated government securities. It is for this reason that these funds possess lower levels of risk and are apt for risk-averse investors.

   6. Credit Opportunities Funds

      Credit Opportunities Funds mostly invest in low-rated securities that have the potential to provide higher returns. Naturally, these funds are the riskiest class of debt funds.

   7. Fixed Maturity Plans

      Fixed maturity plans (FMPs) are close-ended debt funds that invest in fixed income securities such as government bonds. You may invest in FMPs only during the fund offer period, and the investment will be locked in for a predefined period.

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1. Balanced or Hybrid Mutual Funds

   Balanced or hybrid mutual funds invest across both equity and debt instruments. The main objective of hybrid funds is to balance the risk-reward ratio by diversifying the portfolio. The fund manager would modify the asset allocation of the fund depending on the market condition, to benefit the investors and reduce the risk levels. Investing in hybrid funds is an excellent way of diversifying your portfolio as you would gain exposure to both equity and debt instruments. The debt funds are further classified as below:

   1. Equity-Oriented Hybrid Funds

      Equity-oriented hybrid funds are those that invest at least 65% of their portfolio in equities while the rest is invested in fixed-income instruments.

   2. Debt-Oriented Hybrid Funds

      Debt-oriented hybrid funds allocate at least 65% of their portfolio in fixed-income instruments such as treasury bills and government securities, and the rest is invested inequities.

   3. Monthly Income Plans

      Monthly income plans (MIPs) majorly invest in debt instruments and aim at providing a steady return over time. The equity exposure is usually limited to under 20%. You can decide if you would receive dividends on a monthly, quarterly, or annual basis.

   4. Arbitrage Funds

      Arbitrage funds aim at maximizing the returns by purchasing securities in one market at lower prices and selling them in another market at a premium. However, if the arbitrage opportunities are not available, then the fund manager may choose to invest in debt securities or cash equivalents.

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Why Should You Invest in Mutual Funds?

Investing in mutual funds provides several advantages for investors. To name a few, flexibility, diversification, and expert management of money, make mutual funds an ideal investment option.

1. Investment Handled by Experts ( Fund Managers )

   Fund managers manage the investments pooled by asset management companies (AMCs) or fund houses. These are finance professionals who have an excellent track record of managing investment portfolios. Furthermore, fund managers are backed by a team of analysts and experts who pick the best-performing stocks and assets that have the potential to provide excellent returns for investors in the long run.

2. No Lock-in Period

   Most mutual funds come with no lock-in period. In investments, the lock-in period is a period over which the investments once made cannot be withdrawn. Some investments allow premature withdrawals within the lock-in period in exchange for a penalty. Most mutual funds are open-ended, and they come with varying exit loads on redemption. Only ELSS mutual funds come with a lock-in period.

3. Low Cost

   Investing in mutual funds comes at a low cost, and thereby making it suitable for small investors. Mutual fund houses or asset management companies (AMCs) levy a small amount referred to as the expense ratio on investors to manage their investments. It generally ranges between 0.5% to 1.5% of the total amount invested. The Securities and Exchange Board of India (SEB) has mandated the expense ratio to be under 2.5%.

4. SIP ( Systematic Investment Plan )

   The most significant advantage of investing in mutual funds is that you can invest a small amount regularly via a SIP (systematic investment plan). The frequency of your SIP can be monthly, quarterly, or bi-annually, as per your comfort. Also, you can decide the ticket size of your SIP. However, it cannot be less than the minimum investible amount. You can initiate or terminate a SIP as and when you need. Investing via SIPs alleviates the need to arrange for a lump sum to get started with your mutual fund investment. You can stagger your investments over time with a SIP, and this gives you the benefit of rupee cost averaging in the long run.

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5. Switch Fund Option

   If you would like to move your investments to a different fund of the same fund house, then you have an option to switch your investments to that fund from your existing fund. A good investor knows when to enter and exit a particular fund. In case you see another fund having the potential to outperform the market or your investment objective changes and is in line with that of the new fund, then you can initiate the switch option.

6. Goal-Based Funds

   Individuals invest their hard-earned money with the view of meeting specific financial goals. Mutual funds provide fund plans that help investors meet all their financial goals, be it short-term or long-term. There are mutual fund schemes that suit every individual’s risk profile, investment horizon, and style of investments. Therefore, you have to assess your profile and risk-taking abilities carefully so that you can pick the most suitable fund plan.

7. Diversification

   Unlike stocks, mutual funds invest across asset classes and shares of several companies, thereby providing you with the benefit of diversification. Also, this reduces the concentration risk to a great extent. If one asset class fails to perform up to the expectations, then the other asset classes would make up for the losses. Therefore, investors need not worry about market volatility as the diversified portfolio would provide some stability.

8. Flexibility

   Mutual funds are buzzing these days because they provide the much-needed flexibility to the investors, which most investment options lack in. The combination of investing via a SIP and no lock-in period has made mutual funds an even more lucrative investment option. This means that people may consider investing in mutual funds to accumulate an emergency fund. Also, you can enter and exit a mutual fund plan at any time, which may not be the case with most other investment options. It is for this reason that millennials are preferring mutual funds over any other investment vehicle.

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9. Liquidity

   Since most mutual funds come with no lock-in period, it provides investors with a high degree of liquidity. This makes it easier for the investor to fall back on their mutual fund investment at times of financial crisis. The redemption request can be placed in just a few clicks, and the requests are processed quickly, unlike other investment options. On placing the redemption request, the fund house or the asset management company would credit your money to your bank account in just business 3-7 days.

10. Seamless Process

    Investing in mutual funds is a relatively simple process. Buying and selling of the fund units are all made at the prevailing net asset value (NAV) of the mutual fund plan. As the fund manager and his or her team of experts and analysts are tasked with choosing shares and assets, investors only need to invest, and the rest would be taken care of by the fund manager.

11. Regulated

    All mutual fund houses and mutual fund plans are always under the purview of the Securities and Exchange Board of India (SEBI) and Reserve Bank of India(RBI). Apart from that, the Association of Mutual Funds in India (AMFI), a self-regulatory body formed by all fund houses in the country, also governs fund plans. Therefore, investors need not worry about the safety of their mutual fund investments as they are safe.

12. Ease of Tracking

    One of the most significant advantages of investing in mutual funds is that tracking investments is easy and straightforward. Fund houses understand that it is hard for investors to take some time out of their busy schedules to track their finances, and hence, they provide regular statements of their investments. This makes it a lot easier for them to track their investments and make decisions accordingly. If you invest in mutual funds via a third party, then you can also track your investments on their portal.

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13. Tax-Saving

    ELSS or Equity-Linked Savings Scheme is an equity-oriented mutual fund that provides tax deductions of up to Rs 1,50,000 a year under the Section 80C provision. By making full utilization of the Section 80C limit, you can save up to Rs 46,800 a year in taxes. ELSS is the most popular tax-saving investment option under Section 80C of the Income Tax Act, 1961. It comes with a lock-in period of just three years, the shortest of all tax-saving investments. Investing in ELSS provides you with the dual benefit of tax deductions and wealth accumulation over time.

14. Rupee Cost Averaging

    On investing in mutual funds via a SIP, you get the benefit of rupee cost averaging over time. When the markets fall, you buy more units while you purchase fewer units when the markets are booming. Therefore, over time, your cost of purchase of fund units is averaged out. This is called the rupee cost averaging. Investing in mutual funds via a SIP is beneficial during both market ups and downs, and there is no need to time the markets. This benefit is not available when you invest in mutual funds via a lump sum.

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15. No Need to Time Markets

    When you are investing in mutual funds via a SIP, there is no need to time markets. This is because the rupee cost averaging phenomenon ensures that your cost of purchase of fund units is on the lower side. However, you have to continue investing via a SIP for a long period. Therefore, you can invest in mutual funds whenever you feel like it. There is no ‘right time’ as such to investing in mutual funds. The best time is now!

Who Should Invest in Mutual Funds?

Everyone who has a particular financial goal, be it short-term or long-term, should consider investing in mutual funds. Investing in mutual funds is an excellent way to accomplish your goals faster. There are mutual fund plans that suit all personas. Investors need to assess their risk profile, investment horizon, and goals before getting started with their mutual fund investment. For example, if you are risk-averse and planning to purchase a car in five years, then you may consider investing in gilt funds. If you are ready to take some risk and are planning to buy a house in a period of fifteen to twenty years, then you may consider investing in equity funds. If your investment horizon is less than two years and you are looking to earn higher returns than a regular savings bank account, then you may consider parking your surplus funds in a liquid fund.

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