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Different Types of Mutual Funds
Mutual funds offer one of the most comprehensive, easy and flexible ways to create a diversified portfolio of investments. There are different types of mutual funds that offer different options to suit investors’ diverse risk appetites. Let us understand the different types of mutual funds available currently in the market to help you make an informed investment decision.
Broadly, any mutual fund will either invest in equities, debt or a mix of both. Further, they can be open-ended or close-ended mutual fund schemes.
Open-ended funds
In an open-ended mutual fund, an investor can invest or enter and redeem or exit at any point of time. It does not have a fixed maturity period.
Close-ended funds
Close-ended mutual funds have a fixed maturity date. An investor can only invest or enter in these type of schemes during the initial period known as the New Fund Offer or NFO period. His/her investment will automatically be redeemed on the maturity date. They are listed on stock exchange(s).
Let’s take a look at the various types of equity and debt mutual funds available in India:
1. Equity or growth schemes These are one of the most popular mutual fund schemes. They allow investors to participate in stock markets. Though categorised as high risk, these schemes also have a high return potential in the long run. They are ideal for investors in their prime earning stage, looking to build a portfolio that gives them superior returns over the long-term. Normally an equity fund or diversified equity fund as it is commonly called invests over a range of sectors to distribute the risk.
Equity funds can be further divided into three categories:
Sector-specific funds:
These are mutual funds that invest in a specific sector. These can be sectors like infrastructure, banking, mining, etc. or specific segments like mid-cap, small-cap or large-cap segments. They are suitable for investors having a high risk appetite and have the potential to give high returns.
Index funds:
Index funds are ideal for investors who want to invest in equity mutual funds but at the same time don’t want to depend on the fund manager. An index mutual fund follows the same strategy as the index it is based on.
For example, if an index fund follows the BSE Index as the replicating index and if it has a 20% weightage in let’s say Stock A, then the index fund will also invest 20% of its assets in Stock A.
Index funds promise returns in line with the index they mirror. Further, they also limit the loss to the proportional loss of the index they follows, making them suitable for investors with a medium risk appetite.
Tax saving funds:
These funds offer tax benefits to investors. They invest in equities and are also called Equity Linked Saving Schemes (ELSS). These type of schemes have a 3 year lock-in period. The investments in the scheme are eligible for tax deduction u/s 80C of the Income-Tax Act, 1961.
2. Money market funds or liquid funds:These funds invest in short-term debt instruments, looking to give a reasonable return to investors over a short period of time. These funds are suitable for investors with a low risk appetite who are looking at parking their surplus funds over a short-term. These are an alternative to putting money in a savings bank account.
3. Fixed income or debt mutual funds: These funds invest a majority of the money in debt - fixed income i.e. fixed coupon bearing instruments like government securities, bonds, debentures, etc. They have a low-risk-low-return outlook and are ideal for investors with a low risk appetite looking at generating a steady income. However, they are subject to credit risk.
4. Balanced funds:As the name suggests, these are mutual fund schemes that divide their investments between equity and debt. The allocation may keep changing based on market risks. They are more suitable for investors who are looking at a combination of moderate returns with comparatively low risk.
5. Hybrid / Monthly Income Plans (MIP):These funds are similar to balanced funds but the proportion of equity assets is lesser compared to balanced funds. Hence, they are also called marginal equity funds. They are especially suitable for investors who are retired and want a regular income with comparatively low risk.
6. Gilt funds:These funds invest only in government securities. They are preferred by investors who are risk averse and want no credit risk associated with their investment. However, they are subject to high interest rate risk.
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Diversify your investments, don’t put all your eggs in one basket.
Determine your asset allocation (mix of investments that should comprise your portfolio) before you invest.
Evaluate the tax implications and/or benefits before investing.
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