Last Updated on Jun 14, 2022 by Aradhana Gotur
Mutual funds are one of the best ways of diversifying your portfolio. Not only does a mutual fund investment help in long-term wealth creation, but a certain type of scheme also offers tax benefits. Continue to read the various types of funds, how these work for you, and how to choose the right one.
Table of Contents
What is a mutual fund?
A mutual fund is an asset class where a fund manager pools funds from several investors and parks them across investments such as bonds, equity, debt, and more, depending on the investment objective (mentioned in the offer document).
How do mutual funds work?
One of the most significant advantages of mutual funds is that they are professionally managed. Known as a fund managers, they are responsible for investing the pool of funds in select instruments in line with the fund’s objective. Besides, the fund manager monitors the performance of the mutual fund and reshuffles the funds from bad-performing investments to better ones.
Unlike equity, when you purchase a mutual fund, you are not allotted individual shares but a unit of the mutual fund in proportion to your investment. Nevertheless, the value of a unit increases or decreases as per the value of the fund’s underlying assets. And such a profit or loss is proportionately shared by all the investors in the scheme.
Different types of mutual funds
Mutual funds in themselves are a vast asset class. Various types of mutual fund schemes are designed to meet the evolving needs of investors. Let’s take a look at the broad factors based on which mutual funds are classified.
- Based on the entry barrier
- Based on the asset class
- Based on speciality
- Based on the investment objective
Now let us take a look at how many types of mutual funds are there in India.
Based on the entry barrier
Under this category, mutual funds are classified based on the ease of entering and exiting the scheme.
Such types of mutual fund schemes are known for the liquidity that they offer. These are open for a subscription (buy/purchase) and redemption (sell) at all times as there is no fixed maturity period. You can trade units of an open-ended fund at the Net Asset Value (NAV), which is ascertained daily when the market closes.
As the name suggests, close-ended funds have a fixed maturity period, typically ranging from 3 to 7 yrs. Here, a fixed number of units are issued and listed on a stock exchange. Unlike an open-ended fund, you cannot enter or exit this fund as you wish. You can only invest in a close-ended fund during the initial period, regarded as the New Fund Offer (NFO) period.
If you wish to invest in this fund later, you can do so by purchasing the units listed on a stock exchange, either at a premium or a discount on NAV. This feature makes a close-ended fund very much like an exchange-traded fund (ETF). Since the fund has a fixed maturity period, your investment will automatically be redeemed on the maturity date.
This type of mutual fund is a combination of an open-ended and a close-ended fund. You can invest or exit from an interval fund only at specific intervals at the discretion of the mutual fund house. Once you invest in an interval fund, your money is locked in until maturity.
Based on the asset classes
Under this category, mutual funds are classified based on the underlying asset or nature of the investment.
Equity or growth schemes
These types of mutual funds in India allow you to indirectly invest in stock markets, i.e. shares or related instruments. The aim here is to offer capital appreciation over the medium- to long-term. Since equity, the underlying asset, has a considerable risk element, growth mutual funds also carry high risk. Nonetheless, the risk is mitigated as the funds are spread across equities of various industries.
Just like equity, a growth scheme also has the potential to generate high returns in the long term. You can consider investing in equity funds if you are looking for capital appreciation, have a high-risk appetite, and have a long-term investment horizon.
Debt or fixed-income funds
These types of mutual funds in India majorly invest in debt or fixed-income instruments such as gilts, bonds, debentures, and money-market securities. As such, a debt fund offers a fixed rate of interest and is relatively less risky than an equity fund. This fund provides capital security and moderate growth and is suitable if you want to receive a stable income by assuming a low risk.
Balanced or hybrid funds
These types of mutual funds scheme invest in both equity and debt instruments as per the fund’s investment objective. Ergo, these offer the best of both the world – high growth via equity and a regular income through debt avenues. A typical hybrid fund invests 60% in equity and 40% in debt instruments.
Based on speciality
Under this category, mutual funds are classified based on a special factor.
Sectoral or sector-specific funds
As the name suggests, these types of mutual fund schemes invest in a specific sector. For instance, IT funds invest only in information technology stocks, whereas infrastructure funds invest solely in companies or instruments related to the said infrastructure sector. Besides, they can also be classified based on the segment they invest in such as mid-cap, small-cap, and large-cap. Risk and returns are tied to the nature and performance of the said sector.
These invest in underlying instruments of a particular stock market index with the objective to mirror its movement and returns. For instance, a fund may replicate the Nifty by buying stocks that represent the NSE index. Index funds carry a medium risk because here loss is limited to the proportionate loss of the index.
Fund of funds
These invest in other mutual funds or other schemes of the same mutual fund. The benefit of such a scheme is that you can enjoy greater diversification, which spreads the risks across multiple schemes. The returns depend on the performance of the target mutual fund. These can be relatively safer as the funds hold investments in other funds and adjust the risk.
Emerging market funds
These types of mutual funds invest in developing countries or economies showing potential to grow. They carry higher risks due to the dynamic political and economic situations of the country.
Also known as foreign funds, these invest in stocks of companies located in other parts of the world. Such companies could be part of emerging economies as well but not the ones situated in your own country.
Such funds invest in companies located in any part of the world. However, global funds differ from international funds as they can also invest in your own country.
Real estate funds
These types of schemes allow you to be an indirect participant in the real estate sector. Here, the fund can invest in builders, realtors, property management companies, established property firms, and even companies offering loans.
Commodity-focused stock funds
These types of mutual funds indirectly invest in the commodities via companies working in the said market, which can be mining or producers of commodities.
Unlike traditional mutual funds, leveraged funds earn when the markets fall. Besides, inverse funds make a loss when markets perform well. Evidently, these are highly risky and are only well-suited for those with a high-risk appetite.
Exchange-traded Fund (ETF)
These have the qualities of both open and close-ended mutual funds. ETFs are listed on the stock exchanges and thus offer liquidity. As these are managed passively, they tend to carry lower service charges like the entry and exit loads.
Money market funds or liquid funds
As the name suggests, liquid funds are invested in the money market or short-term debt instruments having a tenure of up to 91 days. The main objective of money market funds is to offer a reasonable return to investors in the short term. Money market funds are highly liquid and relatively less risky, which makes them suitable if you wish to park your surplus for a short time.
These types of mutual funds only invest in government securities. They are well-suited for risk-averse investors and those who wish to invest in investments not associated with credit risk. However, gilt funds carry high-interest rate risk.
Based on the investment objective
A mutual fund can have various objectives, based on which they are classified as below.
The primary objective of growth funds is to offer capital appreciation. These types of mutual funds majorly invest in equity, making them risky but ideal for long-term wealth generation.
These types of funds invest primarily in fixed-income instruments like bonds and debentures. The aim here is to offer capital protection and regular income.
Such mutual funds scheme invest with the purpose of providing liquidity. These primarily park funds in ultra- or short-term instruments such as treasury bills, commercial papers, and the likes. These are relatively less risky and offer moderate returns, making them ideal for investors with short-term investment horizons. Read the list of top 10 liquid funds in 2022.
Tax-saving funds or Equity-Linked Saving Schemes (ELSS)
This type of mutual fund offers tax benefits to investors. Since the underlying asset here is equity, the fund is also called Equity Linked Saving Schemes (ELSS). Tax-saving funds have a lock-in period or fixed maturity period of 3 yrs and are eligible for tax deduction under section 80C of the Income Tax Act, 1961. Such funds are considered high on risk and also offer high returns if the scheme performs well.
Capital protection funds
In such types of mutual fund schemes, the pool of money is split between fixed-income instruments and equity. As such, this mutual fund investment would offer capital protection and income in the form of returns.
These types of mutual fund schemes invest for a very long-term time, with an objective to provide regular returns around the time when the investor plans to retire. Investments in such a fund may be split between equity and debt, giving the best of both worlds. Pension funds allow you to either withdraw the returns in lump sum as a pension or a combination of the two modes.
Monthly Income Plans (MIP)
These are best suited for retirees as the majority of the funds are invested in debt mutual funds, thus reducing equity exposure. These carry low risk and offer a regular monthly income.
Fixed Maturity Funds (FMP)
These types of funds have a fixed maturity period between 1 and 5 yrs and invest in fixed-income securities. These are well-suited for those who wish to earn a monthly income.
Income streams of mutual fund investments
- Mutual funds earn dividends from investing in stocks and interest income from bonds. A fund pays out most of such income over the year to the investors. Alternatively, you can choose to reinvest such earnings in the fund and get more units of the scheme.
- The second income stream is capital gains, which the fund earns by selling securities whose prices have increased. Most fund houses pass such gains to investors.
- Finally, if the fund continues to hold securities whose prices have increased, the NAV of the fund also increases. You can then earn a profit by selling these units.
Mutual fund fees
Mutual funds have two types of charges – one-time and recurring. Also referred to as transaction charges, one-time charges are incurred during the initial period for the investment. These can be the entry load, which you have to pay when purchasing a fund unit. The exit load, on the other hand, is levied on redeeming the mutual fund units.
Also referred to as periodic fees, recurring charges are paid more frequently – on a daily, quarterly or annual basis. These are generally charged towards the maintenance of the portfolio, marketing, advising, and other expenses. Recurring fees can be management fees, account fees, distribution and service fees, and so on.
Given a plethora of options, choosing the right mutual fund for your requirements may not be an easy task. Therefore, it is essential to first evaluate your needs and take them as a starting point to pick the best scheme. You can use Tickertape Mutual Fund Screener and Mutual Fund Pages to first discover funds and then ascertain their investment feasibility by evaluating them individually. If needed, you can consult a professional for advice.
How to choose the right mutual fund?
Choosing one of the various types of mutual funds available in the market seems like a herculean task. However, Tickertape Mutual Fund Screener makes it a simple, quick, and easy process. But first, you will have to be sure about your investment needs, financial goals, risk appetite, return expectation, and time horizon. Then, select the broader category of the mutual fund that will most suit your specific needs.
Once you understand your needs and goals, head to Tickertape Mutual Fund Screener to shortlist the top mutual funds to fit your portfolio. The Screener is built with multiple filters and key metrics based on risk, returns, volatility and other parameters. You can choose from these filters and accordingly shortlist mutual funds in no time. You can further evaluate individual schemes using Tickertape’s Mutual Fund Pages, which host comprehensive information about the fund – be it peers, constituents or taxation.
What are direct and regular plans?
Mutual funds come in two variants – direct and regular plans. While you directly approach the Asset Management Company or the fund house to buy direct funds, you buy regular plans through an intermediary. Direct funds are cost-effective as there are no commissions involved in buying them. However, regular funds come with a commission that you indirectly pay to the distributor.
Can I sell my units back to the mutual fund if it is a close-ended scheme?
No, you cannot sell your units back to a close-ended mutual fund. However, since units of close-ended schemes are listed on the stock exchanges after the New Fund Offer (NFO) period is over, you can sell them via the stock exchanges.
Which type of mutual fund scheme should I invest in to enjoy the safety of capital and fixed returns?
Debt funds have relatively low risk as they invest in fixed-income instruments, making them a safe investment. However, no market-related investments are 100% risk-free. Therefore, it is best to consult a financial advisor before investing in one.
Which mutual fund is best suited if I want to earn regular income after retirement?
Keeping in mind your retirement needs, you may consider pension funds, monthly income plans or fixed maturity plans. These have relatively low risk and offer moderate returns as capital preservation is their main objective.
Which mutual funds offer high returns along with tax benefits?
ELSS or tax-saving mutual funds offer high returns and tax benefits. However, be informed that these types of funds also have high risk as they primarily invest in equity.
Is there a type of mutual fund that earns a profit when the market is down?
Inverse or leveraged funds tend to earn profits when the market is down and incur losses when it is performing well. However, these are highly risky.
What are the 3 types of mutual funds based on the asset class?
Based on the underlying asset that a scheme invests in, a mutual fund can be of three types – equity funds, debt funds, and hybrid/balanced funds.