Mutual funds are a collective investment scheme. There are a lot of mutual funds options. Further to complicate matters, there are different types of mutual funds from every major business fund house. In this commotion, how will you choose the right type of mutual fund for you?
Mutual funds can be a boon when you can’t make direct investments. Every person must consider investing if he/she is planning not just to save but grow his wealth. With the financial industry growing complicated every day it’s our motto to educate every Indian investor @ SmartMoneyGoal
Different types of Mutual Funds
Mutual funds can be classified based on following parameters
1) The type of assets they manage – Equity, Bonds, Cash, Real-Estate etc.,
2) The time range of the funds – Close & Open ended. Even Interval funds
Classifications of mutual funds based on assets
1) Equity mutual funds
Equity mutual funds are funds which collect funds from investors and make long term investments in equity/stocks. While in short term they can be risky, equity mutual funds give the best possible returns in long term. Most of the funds known to Indian investor community belong to equity mutual funds. They can be be further classified based on their operation/benefits
- Diversified equity – They predominantly invest in stocks from different size of companies from different sectors. They are good because they give diversification of underlying assets held by the fund. They invest in wide range of stocks -from small market-cap stocks like Nucleus Software to ultra-large companies like Reliance, ITC etc., HDFC Top200 fund, IDFC Premier Equity fund all belong to this category of Diversified Equity funds
- Index mutual funds – Index mutual funds are for the conservative investors. They have the risk of stock markets alone. As the name indicates , they invest in the entire capitalization of the index. Most of the time, Index funds are passively managed ie., there is no constant buying and selling. This translates to low fund management charges and peace of mind for investor. If you’re skeptical about abilities of all fund managers, then get yourself an Index fund.
- Sectoral/Thematic funds– Sectoral funds typically invest in one sector. There are variety of sectoral funds like Banking, IT, Infrastructure, Commodities etc., Sectoral funds carry higher risk-reward ratio compared to Index or diversified funds. They become popular during boom periods. Remember the boom of 2006-07 when every fund house was selling Infrastructure funds as the next big thing? Try to stay away from sector funds if you’re a low risk investor.
- Tax saving mutual funds – Tax saving mutual funds are ELSS funds which have tax benefits under section 80C. The government encourages tax saving schemes to get Indians exposed to equity. You can get a maximum of Rs. 1 lakh as deduction. HDFC Tax Saver, ICICI Pru Tax plan are tax saving mutual funds belonging to this category.
2) Debt/Income mutual funds
Debt mutual funds invest in Corporate deposits, government securities,debentures and other fixed income products. They are primarily based on interest from these instruments. The returns are comparatively lower than equity funds. But the risks are also lower and are preferred by low risk investors. Check out the debt mutual funds here
3) Balanced mutual funds
Balanced mutual funds invest in debt and equity in some pre-determined proportions. This percentage is disclosed at the time of investment. Balanced funds are ideal for investors who want to combine debt and equity in same mutual fund. They reduce the equity when its goes beyond stipulated percentage of fund value and vice-versa when it goes below.
4) REIT – Real Estate Funds
Real Estate trusts (REIT) are funds that invest in Real estate on behalf of investors. Have you ever longed that you can’t invest in real estate as it’s too costly. Welcome to REITs. These funds collect money and buy real estate which they sell for a profit. Sometimes they also own and rent them for long term lease. The mode of operation differs among funds. These funds are not popular in India much now. However, we can expect them to gain popularity in future.
5) Gold ETFs
Gold ETFs cannot be strictly called mutual funds. They invest in gold and each unit in an ETF represents one gram. They securely save gold in lockers on behalf of investors and investors are credited with units in their demat accounts. These units are traded in the NSE/BSE. They have great advantage of easy maintenance, exempt from wealth tax and are ideal for portfolio diversification.
Definitely read: options to invest in gold
6) Liquid mutual Funds
Liquid funds are funds that invest in treasury bills, certificate of deposits and deposits with low time frame. They ensure that the corpus is available as cash to investors at short notice. They have no lock-in period and returned around 9%per annum last year. These are best place to invest money instead of savings deposit as they’re extremely liquid. They’re among the higher assets under management for fund houses in short-term. Liquid funds details here
For a word level, mutual fund classification check this Investopedia mutual funds article
Classification of mutual funds based on time frame
All the asset based funds listed above, either fall into the open-funded or close-ended category. Let us see what they are…
1) Open Ended mutual funds
Open Ended mutual funds are funds that do not have an end date (atleast hypothetically). Users can invest in the funds and withdraw money as they desire at market prices. Most of diversified funds tend to be Open-ended so that they can provide liquidity to investors.
2) Close Ended mutual funds
Closed Ended funds typically furnish the fund end date at initial launch itself. They typically operate to take benefit of any momentum in the market. That’s reason why they were invented but Not sure if that’s happening 🙂 . So for example , if a close ended fund with 5 years launches in 2011, they have to close the fund and return to investors by 2016. But many funds convert them to open ended to cover sub-optimal performance. That’s Another reason why we ask investors to avoid close ended funds. However you can consider below options
- Fixed Maturity Plans – These are close ended debt schemes that invest in debt and money market instruments. They are much like fixed deposits except that return may vary little. They are called fixed maturity because just like bonds, the asset is held for a certain period till maturity. They have low expense ratio.
- Capital Protection Funds – A capital protection fund is a hybrid fund. They typically invest 70-80%in debt and the rest in equities. As name indicates the main goal is capital protection and not returns. Ideal for the low risk investor. Over the last 3 years, these funds on an average have managed 6.2% returns per annum.
Related post: Best equity mutual funds in India
Hope, you must have got an idea about the different types of mutual funds. In India, where financial literacy is just growing it is our duty as an investor to be aware. It is our money on the table, so it’s our responsibility to take care of it. Let us know what you think . We would like to hear your comments below.