In a mutual fund, a company collects money from many people and invests it in stocks, bonds, and other assets. Portfolios are the total holdings of stocks, bonds, and other assets the fund owns. Shares held by each investor represent these holdings.
Mutual fund investors should know the types of mutual funds available and their benefits. Let’s find out how mutual funds are classified.
Types of Mutual Funds Based on Asset Class
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Equity Funds
Equity Mutual funds invest primarily in stocks, they are also referred to as stock funds. They pool together money from various investors from diverse backgrounds to purchase shares/stocks of multiple companies. Equity funds have the potential to bring significant returns over a period. Their gains and losses are solely determined by how the shares they invest in perform (price-hikes or price-drops). Because of this, the risk associated with these funds tends to be higher as well.
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Debt Funds
Bonds, securities, and Treasury Bills are the direct investments of debt funds. They invest in several fixed income instruments, including Fixed Maturity Plans (FMPs), Gilt Funds, Liquid Funds, Short-Term Plans, Long-Term Bonds, Monthly Income Plans, etc. Passive investors who want regular income (interest and capital appreciation) without taking on significant risk can find these investments a great option since they come with a fixed interest rate and maturity date.
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Money Market Funds
As with the stock market, investors also trade stocks in the money market, otherwise known as the capital market or cash market. By issuing money market securities, such as bonds, T-bills, dated securities, and certificates of deposit, the government runs it in partnership with banks, financial institutions, and other corporations. The fund manager invests your money, and dividends are paid out periodically. The risk of money market funds can be considerably reduced if they are invested in a short-term plan (not longer than 13 months).
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Hybrid Funds
A hybrid fund (Balanced Fund) combines stocks and bonds, bridging the gap between equity and debt funds. By distributing 60% of assets in stocks and the rest in bonds, it combines the best of two mutual funds. The ratio can be variable or fixed. Investing in hybrid funds is suitable for investors seeking higher returns on debt rather than sticking to lower-income schemes with low incomes.
Types of Mutual Funds Based on Investment Goals
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Growth Funds
Generally, growth funds allocate a substantial portion to stocks and growth sectors, suitable for investors (primarily Millennials) who have a surplus of cash to put into riskier (but potentially high-returning) plans or who are optimistic about the scheme.
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Income Funds
In the family of debt mutual funds, income funds invest their money in various investments, including bonds and certificates of deposit. Historically, investors have earned better returns than deposits when income funds are created by skilled fund managers who keep the portfolio in ta with rate fluctuations without compromising its creditworthiness. A risk-averse investor with a 2-3 year outlook is best suited.
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Liquid Funds
As liquid funds invest in debt instruments and money markets for up to 91 days, they also fall into the debt fund category. It is possible to invest up to Rs 10 lakh in liquid funds. A feature that sets them apart from other debt funds is how Net Asset Value is calculated. A liquid fund’s NAV is calculated for 365 days (including Sundays), while additional funds use only business days to calculate the NAV.
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Tax-Saving Funds
Equity Linked Saving Schemes (ELSS) have steadily gained popularity among investors in recent years. As well as offering the benefit of wealth maximization and tax savings, they come with a three-year lock-in period, which is among the lowest in the industry. They are best suited for salaried investors with a long-term investment horizon due to their emphasis on equity (and related products). These funds tend to generate non-taxed returns of 14-16%.
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Aggressive Growth Funds
A slightly riskier investment, the Aggressive Growth Fund is intended to produce steep monetary gains. While the fund is susceptible to market volatility, one can choose it based on its beta (the measure of how the fund moves compared to the market). An aggressive growth fund, for instance, would reflect a beta of 1.10 or higher if the market had a beta of 1.
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Capital Protection Funds
Capital protection funds protect the principle but offer comparatively lower returns (at best 12%). The fund manager invests part of the amount in bonds or CDs and the balance in stocks. Although the risk of loss is limited, it is advisable to continue investing for at least three years (at the end of the year) to protect your money.
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Fixed Maturity Funds
Many investors choose to invest at the end of the financial year to benefit from triple indexation, which lowers their tax liability. If you are not comfortable with debt market trends and their underlying risks, fixed-term plans (FMPs) provide an excellent alternative. This is because they invest in bonds, equities, money market funds, etc. FMP, being a closed plan, has a predetermined term that can vary from one month to five years (just like FDs). The fund manager allocates the money to a similar maturity investment to receive the accumulated interest from the FMP at maturity.
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Pension Funds
Keep a portion of your income in a long-term pension fund of your choice so that your family can enjoy the benefits of accumulated wealth. A pension fund can help you cope with any emergency (such as medical emergencies). Please don’t rely solely on your savings account for your golden years because it will run out (no matter how big). Consider schemes like employer pension funds.
Types of Mutual Funds Based on Structure
A mutual fund can also be classified by its risk profile, asset class, etc. Classification based on structure– open-ended funds, closed-ended funds, interval funds – is quite broad, and differentiation depends primarily on the ability to purchase and sell individual mutual fund units.
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Open-Ended Funds
The number of units traded or a specific tenure are not constraints for open-ended funds. As a result, the unit capital continuously changes with new entries and exits. Investors can trade funds when it suits them and exit at the prevailing NAV (Net Asset Value). An open-ended fund can also stop taking in new investors if it cannot manage significant funds.
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Closed-Ended Funds
In closed-ended funds, the unit capital to invest is predefined. This means that the fund company cannot sell more units than agreed upon. Some funds also have a New Fund Offer (NFO) period, during which units can be purchased. Fund managers can choose any fund size for NFOs because they have a pre-defined maturity tenure. SEBI has therefore mandated investors have the option to either repurchase or list the funds on the stock exchange as a method for exiting the schemes.
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Interval Funds
These funds are open to purchase or redemption only during specific intervals (determined by the fund house) and are closed the rest of the time. In addition, no transactions will be permitted for at least two years. Investors can use these funds to save up a lump sum for a financial goal within three to twelve months.
Final Word
Recategorization of mutual fund schemes by SEBI was announced on October 6, 2017. The move was made to bring uniformity as mutual fund houses had launched several mutual fund schemes. After this move, you may find it relatively easy to invest in mutual funds because investors select a mutual fund scheme that matches their investment and risk tolerance objectives. In this video, we have discussed types of mutual funds based on structure, asset class, and investment goals. Let us know if you have any doubts in the comment section
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