You must have heard about countless AMCs and Mutual Fund schemes, but there are different types of mutual funds available to invest. These types of mutual funds are based on various factors.
There is a complete universe of Mutual Funds available in the market for investment, it’s actually a tricky task to identify the best fund for investment.
- The first step is to identify the need of investment and match the fund accordingly.
- The next step would be to figure out your financial goals: Is it to build wealth quickly, at a moderate pace or at a slow pace? And the last main thing to consider is the risk you are willing to take based on your return expectations.
- The highest returns are generally offered by the funds offering the highest risks. So, if you want returns quickly and are willing to take risks than that is the fund to go for. But if your objective is to build wealth slowly, then going in for a medium or low risk mutual fund is ideal.
Since mutual funds always come with a factor of risk associated with them, no matter how small, it is imperative that investors read their policy documents carefully before investing to ensure that they and their investors have understood exactly what they have invested in and all the facilities that are available to them with that investment.
To understand what form of investment yields what kind of returns and what are their associated risks you must know everything about all the types of mutual funds :
So, whenever it comes to investing in Mutual Funds, first thing that comes to your mind: Which Mutual Fund is The Best? In order to answer that question, you should be knowing the following types of Mutual Funds based on the asset class:
- Equity Oriented Funds
- Debt Oriented Funds
- Balanced/Hybrid Funds
- Money Market Funds
- Gilt Funds
- Other Funds – Commodity, Real Estate etc.
Further, based on the Investment Goals we can further classify funds in the following types:
- Regular Income Funds
- Tax Saver Funds / ELSS
- Liquidity Funds
- Growth Funds
- Capital Protection Funds
- Maturity Funds
- Pension Funds
Further based on the riskiness, we can also categorize mutual funds in the following:
- High Risk Funds
- Medium Risk Funds
- Low Risk Funds
- Very Low Risk Funds
Further on the basis of specialization or theme of fund the following can be the categories:
- Sectorial Based Theme
- Index Based Theme
- Real Estate Based Funds
- Blue-chip/Ultra Blue-chip Companies Based Funds
- Global Funds
Further we should be knowing that, every mutual funds have the following set of schemes:
- Open Ended
- Close Ended
These above 2 schemes can be further categorized into the following:
- Regular Growth Schemes
- Direct Growth Schemes
- Dividend Payout Schemes
- Dividend Reinvestment Schemes
So, whenever you have to invest in any Funds, the following things are necessary to understand first:
- Why I am investing?
- What is my goal for Investment?
- What is my Risk Taking Capacity?
- What is my Risk Tolerance Level?
- What is my Investment Horizon?
Oh No!! I guess I have given you so many types of mutual funds and you must be really confused now. Do not worry, I will try to explain all above mentioned categories through practical examples that I have quoted below. Just go ahead and read further.
So let us take a Practical Example, lets assume Mr. Richie Rich is a middle class person and earning Rs. 70000/- p.m. and he wants to invest Rs. 30000/- in Mutual Funds. So he approached a Financial Advisor i.e. CA Pankaj Chhabra and asked him to suggest some mutual funds for investment.
Now, Mr. Pankaj did the following process with Mr. Richie Rich:
- He performed Risk Assessment Procedure with Mr. Richie Rich to know in which category he falls i.e. Risk Taker or Risk Averse or Risk Taker.
- Now suppose he falls under Risk Taker Category, then he asked him about his investment time horizon, for which he answered – 15 Years
- Further, Mr. Pankaj asked him to define his goal of Investments. So he tagged two goals – one is Retirement Corpus and Second is Child Education.
- Further, Mr. Pankaj asked him about his expected Return from his Investment, for which he replied between 13-15% p.a.
- These funds are available for subscription and redemption throughout the year. All purchases/redemption of these fund units are done at prevailing NAVs.
- These funds are perpetual and have no fixed maturity date, which means that investors can withdraw their funds at any time they want, thus giving them the liquidity they need. There are no limits on how much can be invested in the fund and are therefore are an ideal investment.
- They also tend to be actively managed which means a fund manager picks the places where investments can be made and continuously monitors fund’s portfolio, deciding on which stocks to buy/ sell/ hold and when, using professional judgement backed by analytical research.
- These funds also charge a fee which can be higher than passively managed funds because of the active management.
- Funds which are open for subscription only during the initial offer period and units can be redeemed only at a specified maturity date.
- To provide liquidity, these schemes are compulsorily listed for trade on stock exchange. The units or stocks therefore bought cannot be sold back to the mutual fund, instead they need to be sold through the stock market at the prevailing price of the shares.
- These are funds that have the features of open-ended and close-ended funds. They are open for purchase and redemption at different intervals during specified transaction periods.
- The transaction period needs to be for a minimum of 2 days and there should be at least 15-day gap between two transaction periods.
- The fund management company offers to repurchase units from existing unitholders during these intervals. If unitholders wish to, they can offload shares in favour of the fund.
Types of Mutual Funds Based On Asset Class
- Type of mutual fund scheme that invest in equity stocks/shares of companies.
- These are considered high-risk funds but are best suited for long-term investors as they have the potential for long-term capital appreciation.
- Funds that invest in debt instruments like corporate and government bonds and other fixed income assets. Debt mutual funds lower the risk for investors and provide fixed returns.
- These funds do not deduct tax at source so, if the earning from the investment is more than Rs. 10,000 then the investor is liable to pay the tax on it himself.
Money Market Funds:
- These are funds that invest in highly liquid and near-term instruments e.g. treasury bills, commercial papers etc. They are considered safe investments for those looking to park surplus funds for immediate but moderate returns.
- Money markets are also referred to as cash markets and come with risks in terms of interest, reinvestment, and credit risks.
Balanced or Hybrid Funds:
- Mutual fund schemes which invest in more than one class of assets to diversify the portfolio with an aim to minimize the risks involved. Risks and returns are balanced out this way.
- An example of a hybrid fund would be Franklin India Balanced Fund-DP (G) because in this fund, 65% to 80% of the investment is made in equities and the remaining 20% to 35% is invested in the debt market.
Types of Mutual Funds Based on Investment Objectives
- Under these schemes, money is invested primarily in growth-oriented assets such as equity stocks to provide capital appreciation.
- They are considered to be risky funds volatile over short-term but are ideal for investors with a medium to long-term investment timeline looking for higher returns on their investments.
- Under these schemes, money is invested primarily in fixed-income instruments e.g., Corporate and government bonds, debentures etc. with the purpose of providing capital protection and regular income to investors.
- Under these schemes, money is invested primarily in short-term or very short-term instruments for investors seeking liquidity and principal protection, with commensurate returns e.g., T-Bills, CPs etc.
- They are low on risk with moderate returns and are ideal for investors with short-term investment timelines.
Tax-Saving Funds (ELSS):
- These are funds which invest at least 80% of their assets in equities.
- These are the equity-linked saving schemes (ELSS) which offer tax benefits to the investors under section 80C of the Income Tax Act, 1961.
- They are considered high on risk but also offer the benefit of maximizing the returns if the fund performs well.
Capital Protection Funds:
- These are closed-end hybrid funds where funds are split between investment in fixed income instruments and equity markets.
- This is done to ensure protection of the principal invested during market downturns and simultaneously offer scope for capital appreciation by participating in upturns of the stock market.
Fixed Maturity Funds:
- In fixed maturity funds the assets are invested in debt and money market instruments where the maturity date is either the same as that of the fund or earlier than it.
- The tenure of fixed maturity plan can vary from a few months to a few years.
- Pension funds are mutual funds that are invested in with a really long term goal in mind to save a certain portion of their income for their retirement.
- The investments in such a fund may be split between equities and debt markets where equities act as the risky part of the investment providing higher return and debt markets balance the risk and provide lower but steady returns.
- These funds offer the option to receive returns either as lump sums or a monthly pension at a fixed rate.
Types of Mutual Funds Based on Speciality
- Funds that invest in a particular sector of the economy e.g., Infrastructure funds invest only in those instruments or companies that relate to the infrastructure sector.
- As returns are tied to the performance of the chosen sector there is more volatility due to lack of diversification.
- These are funds that invest in instruments that represent a particular index on an exchange so as to mirror the movement and returns of the index e.g. buying shares representative of the BSE Sensex.
- They provide broad market exposure, low operating expenses, and low portfolio turnover.
Fund of funds:
- These are funds that invest in other mutual funds rather than investing directly in stocks and returns depend on the performance of the target fund. These funds can also be referred to as multi manager funds.
- These investments lower the risk by spreading investments across multiple funds.
Emerging market funds:
- In these funds investments are made in developing countries that show good prospects for the future.
- They do come with higher risks as a result of the dynamic political and economic situations prevailing in the invested country.
- These are also known as foreign funds as they offer investments in companies located in any part of the world.
- The only companies that will not be invested in will be those located in the investor’s own country.
- These are funds where the investment made by the fund can be in a company in any part of the world.
- They differ from international/foreign funds because investments can be made even in the investor’s own country.
Real estate funds:
- These are the funds that invest in companies that operate in the real estate sectors. These funds can invest in realtors, builders, property management companies and even in companies providing loans.
- The investment in the real estate can be made at any stage: planning phase, partially completed and after completion.
Commodity focused stock funds:
- These funds don’t directly invest in the commodities but invest in companies that are working in the commodity market such as mining companies or producers of commodities.
- These funds can, at times, perform the same way as the commodity, as a result of their association with their production.
Market neutral funds:
- The reason that these funds are called market neutral is that they don’t invest in the markets directly, they invest in treasury bills, ETFs and securities and try to target a fixed and steady growth.
- These funds operate unlike traditional mutual funds as the earnings from these funds happen when the markets fall and when markets do well these funds tend to go into loss.
- Generally meant only for those who are willing to incur massive losses but at the same time can provide huge returns as well.
Asset allocation funds:
- The asset allocation fund comes in two variants:
- the target date fund
- the target allocation funds
- The portfolio managers can adjust the allocated assets to achieve results.
- These funds split the invested amounts and invest it in various instruments like bonds and equity.
- Gilt funds are mutual funds where the funds are invested in government securities for a long term. Therefore, they are virtually risk free and can be the ideal investment for those who don’t want to take risks.
Exchange traded funds:
- These are a mix of both open and close ended mutual funds and are traded on the stock markets. These funds are managed passively and can offer a lot of liquidity.
- As a result of their being managed passively, they tend to have a lower service charge associated with them.
Types Of Mutual Funds Based on Risk:
- These are the mutual funds where the investments made are by those who do not want to take a risk with their money. The investment in such cases are made in places like the debt market and tend to be long term investments.
- As a result of them being low risk, the returns on these investments is also low. One example of a low risk fund would be gilt funds where investments are made in government securities.
- These are the investments that come with a medium amount of risk to the investor. They are ideal for those who are willing to take some risk with the investment and tends to offer higher returns.
- These funds can be used as an investment to build wealth over a longer period of time.
- These are those mutual funds that are ideal for those who are willing to take higher risks with their money and are looking to build their wealth. One example of high risk funds would be inverse mutual funds.
- Even though the risks are high with these funds, they also offer higher returns.