Different Types of Mutual Funds

Different Types of Mutual Funds 

As a first time investor, it can be a daunting task to select the right type of mutual fund to invest in. The first step to accomplishing this is to have an investment objective. That in itself is a dilemma as you will now be thinking about how you should determine an investment objective when investing in mutual funds.

An investment objective can be simply defined as what you expect to achieve from a mutual fund investment in terms of growth and dividends. This objective is based on parameters like the investment term and your risk taking appetite.

Mutual Fund related terms that you should know

Assets: These are the market instruments like stocks, bonds etc. that a mutual fund invests in.

Asset Management Company: This is a company that comprises of a fund manager and financial experts who manage the assets of the mutual fund that you have invested in.

Corpus: The combined total investment of all the investors in a mutual fund.

Exit Load: The cost that you need to pay to withdraw your invested capital from a mutual fund.

Investment Portfolio: This portfolio is the collection of the assets in which an AMC invests. The asset allocation is based on the mutual fund’s investment objective.

NAV: Net Asset Value is the price at which investors can buy or sell their units and is measured by this simple formula –

Net Asset Value =                Market value of assets–Liabilities/

                                       Total number of asset units in the mutual fund on a given day

Here, the market value of assets (or securities like shares,bonds etc.) is the value that your securities in a mutual fund hold on a given day while the liabilities refer to the charges that the Company takes for managing mutual funds.

Types of Mutual Funds

While the wide array of options in mutual funds make for a selection headache, it is also beneficial as it makes it easier for you to find a mutual fund that is in line with your investment objective.

Let’s have a look at the types of mutual funds you can invest in: -

Equity Funds

Equity funds comprise of the largest part of the financial market investment. These funds invest primarily in stocks and have a high risk-return ratio. This ratio implies that shares with higher risk are capable of fetching higher returns.

The stock investment can be in small, mid or large cap companies which can be focused on an individual sector or diversified among different sectors. If you have a high risk-taking appetite and a long-term outlook, investment in equity mutual funds can be very rewarding as the long term capital gains from them are exempted from tax.

Debt/Income Funds

Debt funds invest primarily in corporate or government bonds and securities. Well suited for a less risk taking investor, debt funds are a good option to generate a fixed income as well as fixed returns. The ability of your asset portfolio to counter any unforeseen risk plays an important role. Investment in these funds can be made from a short-term as well as a long term objective. A welcome characteristic of debt funds is that you can avail indexation benefits on long-term investments to save on tax.

Indexation benefits are a measure to safeguard returns on long-term investments from the rise in inflation. The indexation benefit for an investment is calculated using the Cost Inflation Index (CII) value and once applied, gives investors the benefit of paying lower amounts of tax on returns from investments.

A very prominent type of income fund is the Liquid Fund. These are short term funds where the risks are low and the returns are easily liquefiable i.e. can be received in the form of cash.

Balanced Funds

These are the hybrid funds that incorporate equity as well as debt investments. The intent is to generate high income from the equity portion and get steady returns from the debt portion. Moreover, the presence of debt instruments also helps to balance out any losses that you may face from the equity investment.

However, here, the asset allocation is primarily based on different objectives. For example – a Monthly Income Plan is a type of balanced fund where a large percentage is allocated to debt instruments and the remainder to equity instruments. This allows fixed returns at a low risk and a decent exposure to get gains that can be achieved through stock investments.

Other forms of balanced funds might focus more of equity instruments as the objective there would be higher gains, even if the risk level increases a bit.

Index Funds

Index funds are designed to replicate the portfolio of a particular market index like the NIFTY or the S&P BSE 500 Index which expands to Standard & Poor’s Bombay Stock Exchange 500.

Before we go any further, the difference between active and passive management requires explanation. With the market fluctuations involved, most mutual funds are actively managed i.e. constant buying and selling is required to stay on course to attain the objective of the fund.

Now since the index fund follows the pattern of a market index, they do not need to be aggressively monitored and hence, are passively managed. The risks involved are in proportion to the fluctuations of the index it is following.

Gilt Funds

These Funds invest exclusively in government securities where there is null risk by default. However, the values of these fund units are dictated by market volatility and the risk-return ratio for these funds can be seen in the same vein as equity funds.

Global Funds

Global Funds invest in debt and equity instruments in a number of countries across the globe and is an additional layer to the domestic diversification of your capital. These funds are meant for those investors who have a good reading of international markets and an understanding of the country-specific risks involved.

Fund of Funds

This type of fund invests in mutual funds instead of assets. In other words, your investment is diversified among mutual funds rather than market instruments. Here, the performance and returns of the Fund of Funds will be affected neither by the best performing nor the worst performing fund, but the average of all the funds within the portfolio.

As is evident, there is no dearth of options as these different types of mutual funds cater to different investment objectives. So if you are thinking of investing in a mutual fund, ensure that you understand the market risks as well as the fact that the mutual fund selected is in tune with your objective of investing in it.