As a novice investor, it might seem an uphill task to settle on the perfect type of mutual fund for investment. In case of such a dilemma, the first thing to do is to think about your investment objective. Your investment objective is simply described as what you look forward to attain from investment in mutual funds in terms of dividends and growth. The objective depends on factors like your appetite for risk and the investment term.
There is a wide array of mutual funds to choose from. In order to select an option that corresponds to your investment objective, let’s look at the types of mutual funds in India that you can invest in:
1. Equity Funds
Equity funds constitute the biggest segment of the financial investment market. These funds mainly invest in shares that enclose high risk to return ratio (stocks with greater risk will fetch you higher returns). The intention is to produce potentially bigger returns by embracing higher risk. Since these funds involve stocks, profits do swing thereby creating higher risk. Thus, these funds are not for risk-hesitant investors. The investment may be in large, small or mid cap companies and focused on a specific sector or spread among diverse sectors. Equity funds can be categorized as
- Diversified funds: These funds invest in companies across market and sectors. ELSS (Equity Linked Savings Scheme) is one such option that offers tax benefit on investment. However, bear in mind to stay invested for at least three years to claim your tax benefit.
- Index funds: These funds invest in companies that constitute stock market index. The investment in these companies is proportionate to their value in the index. Hence, profits earned through these funds basically correspond to profits produced by the fundamental index. For example, an index fund based on BSE Sensex will fund stocks comprising the Sensex in the equivalent proportion as the constituent shares in the Sensex. As the market fluctuates, most mutual funds have to be managed actively which means constant trading is required to attain the investment objective. However, since the index fund follows the market index they can be managed passively, hence aggressive monitoring is not required. The risks are equivalent to the variations of the index it follows.
- Sectoral funds: These funds invest in companies belonging to a specific sector. For example, IT sector fund invests only in IT stocks while banking sector fund invests in just banking firms. These funds involve higher risk because they focus on a particular sector. Additionally, there are thematic funds such as infrastructure funds that fund a certain investment theme.
If you have a good appetite for risk and a continuing approach, investing in equity funds would be quite valuable as long term capital gains from equity fund investments are exempted from tax.
2. Debt Funds
Debt funds invest mainly in government and corporate securities or bonds. Appropriate for a risk-averse investor, these funds are a good alternative to create a fixed income and fixed returns. They can be categorized into:
- Liquid income or Money market schemes: These funds invest in liquid money market tools for extremely small investment duration (few days). They are appropriate for storing additional capital for brief durations.
- Income funds: These funds invest in corporate bonds, government securities, debentures and money market tools. These funds bring in somewhat higher risk as against gilt funds because they are vulnerable to credit risk. Income funds accompany different investment possibilities such as long term, medium term, short term, and ultra-short term funds to match changing investor wishes
- Gilt funds: These invest in sovereign bonds like state and central government securities. These do not include any credit risk but are exposed to interest rate threats. The value of these bonds varies with movements in interest rates. Additionally, these funds offer different investment spans to meet investor needs.
- FMP (Fixed Maturity Plans): These funds carry a preset tenure like credits, although no profit is guaranteed. They involve investment in securities that develop in proportion to the fund’s development.
The asset portfolio must be capable of countering any unpredicted risk. Investment in debt funds can be done with long term as well as short-term objective
3. Balanced Funds
Balanced or hybrid funds incorporate debt as well as equity investments. The goal is to produce high returns from the equity segment and obtain secure income from the debt segment. In addition, the debt tools help to offset any damages that you might incur from the equity segment. The corpus allocation depends on your investment objectives. They can be categorized into:
- MIP (Monthly Income Plan): It is a kind of hybrid fund where a huge proportion is allotted to debt investments while the remainder goes to the equity segment. This facilitates fixed income at low risk and a modest exposure to collect gains through equity stocks.
- Asset Allocation funds: It focuses more on equity segments as the objective here is to secure higher returns, though the risk level also increases slightly. The equity investment varies broadly from 0% to 90% depending on the market conditions. These funds lack a preset asset allocation.
Other types of funds
4. Global Funds
These funds invest in equity and debt instruments in different countries around the world. It acts as an added cover to the national diversification of your corpus. These funds are intended for investors who have excellent knowledge of global markets and are aware of the nation-specific risks.
- Exchange Traded Funds
The units of this fund operate like a share on the stock market. It may be based on any underlying asset or stock index. These can be traded only within the stock exchange at real time costs which may not be the same as its unit NAV. They include lesser expense ratios in comparison to index or any other equity investments. You need a Demat account in order to invest in ETFs.
- Gold ETFs
These funds are based on gold. You can put money on gold without actually buying it by investing in Gold ETFs. These funds not only relieve you of the troubles of safekeeping gold but also assure you of purity as it invests only in authorized gold bars. You can also avoid making and wastage charges that you normally incur when buying gold from jewellers.
- FoF (Fund of Funds)
These funds invest in additional mutual funds that may belong to the same fund group or others. They can invest in global mutual funds, besides investing in debt, equity or even gold. FoF allows achieving diversification and reduces risk. However, they entail high management expenses.
Apart from offering investors various kinds of mutual funds based on their investment objectives, there are two more kinds of mutual funds that are based on its structure
- Open-ended schemes: These funds allow an investor to contribute or leave at will. They do not have an end date. These funds offer you the ease of trading or redeeming fund units on any business day at current NAV (Net Asset Value).
- Close-ended schemes: These funds are open for investment only during their NFO (New Fund Offer) period. When the offer ends, no further investments are allowed. In addition, the scheme remains active for just a particular time period and when it ends, the funds are handed back to the investors. Since these schemes are registered on the stock market, an investor can sell his units through the market at the existing market price if he wants to leave.
Evidently, there are different types of mutual funds that can cater to your varying investment objectives. If you are willing to take risks and expect higher returns, opt for equity funds. On the other hand, debt funds are ideal for those looking for safer investments. However, if you want a taste of both, go for hybrid or balanced funds which comprise both equity and debt investments. Whatever be your preference, mutual funds would be just right for you.