Mutual funds are versatile and can fit into any investing style. That’s because there are different types of mutual funds in the market. Each mutual fund serves a different purpose. These funds vary in their investment objective, risks, returns as well as taxation. The wide range of mutual funds, therefore, helps you invest in the right fund. Therefore, it is important you understand the different types of mutual funds. It can help you make the right decision. So, let’s enlist the different types of funds for a better understanding of the mutual fund market.
Mutual fund categories
On a broader level, mutual funds are categorized as equity and debt funds. A mix of the two is known as a hybrid fund.
▪ Equity funds
Equity funds mainly invest in stocks of companies. There are various types of equity funds available in the market. They are:
✓ Diversified equity funds: Diversified equity mutual funds are pure equity funds which spreads your invested money across various sectors and companies regardless of their market capitalization.
These are multicap funds and are suitable for a moderate risk-taker. Staying invested for five to six years may deliver potential returns. However, study the fund’s past returns and its objective before investing.
✓ Sector funds: Such funds invest in one particular sector. For example, Banking and Financial Service Fund invests in banking and financial services sector only.
Sector funds can be a good choice for long-term investing. However, this entails higher risk. So, before you invest, it is important to study the sector and analyse how it may outperform the market in future.
✓ Equity-linked savings schemes(ELSS): These are the tax-saving mutual funds that qualify for deduction under Section 80C of the Income Tax Act. Although ELSS funds come with a lock-in period of three years, using the SIP route can make such investment affordable.
✓ Hybrid funds: These are balanced funds that invest in both stocks and bonds. They are considered equity-oriented funds as they invest at least 65% of total money in equity. These are good investment options for beginners.
▪ Debt funds
Debt funds are mutual funds that principally invest in debt instruments like bonds, treasury bills and other fixed income investments. These funds can be further categorized:
✓ Income funds: These funds majorly invest in fixed-income instruments like bonds, government securities and corporate debentures etc. The major focus is on income generation.
It’s important to consider the interest rate. That’s because interest rate volatility has an impact on these funds. Investing during a falling interest rate scenario and exiting when rates tend to rise can benefit you in such funds. If you have one to three years’ time frame in mind, these funds can be a good option.
✓ GILT funds: These funds majorly invest in government securities. Generally, these funds are safe since there is no default risk. However, gilt funds are subjected to interest rate risk. For example, if the interest rate moves up, the yield of a GILT fund goes down as it becomes less attractive and vice versa. Thus, you need to keep a track on the interest rate movements.
✓ Short-term funds: These funds primarily invest in money market instruments like treasury bills and certificate of deposits. The average maturity of such papers are low and the investment is thus suitable for a short-term horizon like three to six months.
✓ Monthly income plans (MIPs): These are debt-oriented hybrid funds with a small allocation in equity and a majority of the investment in debt. MIPs usually pay a monthly dividend. Investors with low to moderate risk profile can consider this as an option in order to receive a regular income. But do remember that the monthly dividend is not a guarantee.
✓ Liquid funds: These invest in short-term debt instruments like commercial papers, treasury bills and corporate deposits. These are a good short-term option.
Now that you know how different mutual funds work, you can choose to invest based on your needs.
Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.