Category : Investing Guides September 13, 20245 minutes read
The types of funds in India cater to almost every kind of investor need there is. Mutual funds can broadly be classified into four types:
- Equity funds: These invest primarily in equities or stocks.
- Debt funds: These invest primarily in fixed-income securities such as bonds.
- Hybrid funds: These invest in equities and fixed-income securities.
- Index funds: These funds track and replicate the returns of an underlying index.
Mutual funds can also be classified based on their investment horizon: short-term, medium-term, or long-term mutual funds.
An SIP, or systematic investment plan is a way to regularly invest portions of your income as it comes in. Here are some of the different types of SIPs to invest in mutual funds
Regular SIP
Top-up SIP
Perpetual SIP
Multi SIP
Booster SIP
A systematic investment plan (SIP) is the practice of regularly investing fixed portions of your funds. A mutual fund SIP allows you to invest a monthly amount of even as little as 500 rs to generate a growing investment fund for yourself.
The 4 types of mutual funds are Equity Funds, Debt Funds, ybrid Funds and Index Funds. This classification of mutual funds is based on the different asset classes that the fund invests in.
Fixed deposits may be considered a reliable investment, but they may generate a poor rate of return compared to many other investment options in India. There is little risk involved in fixed deposits and the returns are also pre-determined. Mutual funds may be a little riskier, but have the potential to earn better returns in the same period of time as a fixed deposit.
Introduction
Mutual funds as an investment option in India have been around for decades, constantly evolving to suit an increasingly specific customer base. There are several types of mutual funds available to investors with different goals and risk-appetites. For instance, investors seeking diversification may opt for hybrid mutual funds that are a combination of equity and debt investments. Investors with a short-term investment horizon may opt for short term mutual funds or short term bond funds. Investors seeking liquid investments may choose liquid funds. Liquid fund returns may be relatively low, but they offer liquidity and low-risk. Let’s understand the types of mutual funds available to investors and their potential benefits.
Every mutual fund has a specific approach to investing. The strategy for investment is based on what is known as an asset class. Each asset class has its own unique pros and cons, which allows you to pick the right kind of investment plan based on your goals. Here are 4 types of mutual funds to invest in that every investor should know:
Equity Funds
Equity funds invest primarily in stocks and may also be known as stock funds. The fund picks out strategic investments from the stock market in some proportion of small cap vs mid cap vs large cap investments. Large and mid cap funds may be relatively less risky than small cap funds. The risk associated with equity is higher, but they also have the potential to generate better returns in favourable conditions.
Here’s a quick guide to the difference between the small cap vs mid cap vs large cap types of equity funds and what they offer to an investor.
| Aspect | Small-Cap Funds | Mid-Cap Funds | Large-Cap Funds |
| Returns | Higher potential returns but with higher risk. | Moderate return potential with moderate growth potential. | Relatively lower potential growth and returns, with relatively lower risk. |
| Growth Potential | High growth potential due to scalability of new businesses | Good growth potential in relatively stable, growing companies | Stable, mature companies with slower growth but stability. |
| Risk | Small companies have survival risk. | Moderate risk compared to small-caps. | Lower risk for established, large scale companies. |
| Investment Horizon | Longer-term investment (5+ years) | Moderate-term investment (3-5 years) | Suitable for both short- and long-term investment (3+ years) |
Debt Funds
These are funds that focus on fixed-income investments like bonds, treasury bills and other securities. Debt funds returns are suitable for investors who want a passive income with negligible risks. There are many types of debt investment funds, these include short duration funds, medium duration funds, long duration funds, floater funds, credit risk funds etc.
Money market mutual funds are a type of debt fund. They invest money in what is known as the cash or money market. These are often government-sanctioned bonds, dated securities and deposit certificates that return interest and dividends over a period of time. Money market mutual funds are considered very low risk when invested in the short term.
Hybrid Funds
To create a more versatile investment profile, you can look at hybrid funds, which are a mix of stocks, bonds. Hybrid mutual funds can be tinkered to provide different expected ratios for risk and reward. Investors who want to take a little extra risk in exchange for higher earning potential would find hybrid mutual funds suitable.
Index Funds
Index funds are investment schemes that follow a particular index. They may follow market indices such as Nifty 50, Nifty 100 etc. and aim to replicate it. The portfolio of the fund changes only when the benchmark index changes.
You can choose from these 4 types of mutual funds to invest in based on your goals, how long you wish to invest your money and what kind of returns you’ll be able to expect from a specific fund.
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Mutual funds can broadly be classified into 4 categories. These include:
- Equity Funds: Primarily invested in equities or stocks. Types of equity funds include smallcap funds, midcap funds, large cap funds, etc.
- Debt Funds: Primarily invested in bonds and other fixed-income securities. Types of debt funds include government bond funds, corporate bond funds, money market funds etc.
- Hybrid Funds: Invested in a balance of equity and debt securities.
- Index Funds: Invest in equities in a particular index such as Nifty 50, Nifty 100 etc. They track an index and aim to replicate the returns.
One of the cardinal rules of investing is that there should be a balance between risk and reward. Low-risk mutual funds are also likely to produce low returns. Very high-risk mutual funds on the other hand can provide relatively higher returns. The most sought-after investment options are low-risk, high-return mutual funds, but these are rare, and many investors will argue that there is no such thing. Returns are balanced around risk, so low risk high-return mutual funds aren’t common or widespread.
The ideal investor for very high-risk mutual funds is someone who is capable of losing money in the short term. Very high-risk mutual funds invest a larger percentage in small and mid-cap stocks which have great growth potential but also higher risks attached. An individual who may be a working professional and has allocated some portion of their savings towards very high-risk mutual funds may be a suitable investor.
Low-risk mutual funds are more suited to those who want to grow their money at a steady pace without exposing it to risk. Debt funds, money market mutual funds and carefully curated hybrid funds are a much more appropriate option for the risk-averse investor.
The different types of mutual funds in India all have their own investment horizon. The funds are categorized on the basis of their maturity period into short, medium and long term funds.
Short-Term Mutual Funds
Funds that have an investment horizon of 1-3 years are known as short term mutual funds and are good for investors who want to invest funds for a short time instead of keeping them idle. There are also ultra short term mutual funds and liquid funds that can be held for less than 90 days. Short-term bond funds are a relatively low risk investment option.
Medium-Term Mutual Funds
Funds with an investment horizon of 3-5 years and are focussed on creating wealth for investors with a lower risk profile are known as medium-duration funds. With the extra duration, medium term mutual funds may be able to navigate market volatility well to find quality investments, as well as to reinvest dividends and growth for greater compounded growth. Medium-duration funds are suitable for investors who want to start investing through monthly income plans. These funds typically invest in safer debt and money market types of securities.
Long-Term Mutual Funds
Funds with an investment horizon of more than 5 years are considered to be long-term. Funds that invest in equity and equity-related securities with an investment horizon of more than five years are categorised as long-term equity funds. They are suitable for investors who are trying to meet long-term objectives like their children’s education or retirement. Long-term equity funds have a relatively low risk level, but are likely to grow very well through steady increments and the benefit of compounded value. The downsides of long-term equity funds are their liquidity and the cost of exiting the fund before maturity. ELSS and small cap funds are good examples of long-term equity funds to invest in.
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Mutual funds can be divided into 3 types based on investment horizon. These include:
- Short-term mutual funds: Schemes with an investment horizon for less than three years are generally considered to be suitable for short-term goals.
- Medium-term mutual funds: Schemes with an investment horizon between 3-5 years are generally considered to be suitable for medium-term goals.
- Long-term mutual funds: Schemes with an investment horizon of over 5 years are generally considered to be suitable for long-term investment goals.
When you’re deciding which of the different types of mutual funds suit you best, there are a few parameters to focus on to help you with the decision. The first question you should ask is, what are your investment goals? Are you looking to turn a quick profit, save enough to buy a car, invest in your retirement, save tax? We’ve looked through the 4 different types of mutual funds with respect to asset classes, but let’s look at mutual funds from the perspective of the goals they need to meet.
Growth Funds
What are growth funds? They can help you grow your wealth relatively quickly, however they are associated with some level of risk. A young person with a disposable income that can be invested in very high-risk mutual funds to maximise growth potential may be a suitable investor for these funds.
Income funds
Risk-averse investors who want stable growth income that is better than simple deposits should look towards income funds. These are low-risk mutual funds that invest in bonds, deposit certificates and other securities.
Tax Saving Funds
Equity linked saving schemes (ELSS) are a strategic investment that can give you a significant deduction in your taxable income up to 1.5 lakhs. In addition to the ELSS returns from growth in stock and dividend, you can also save yourself several thousands of rupees in tax. Salaried individuals investing in the long-term are the ideal candidates for ELSS returns.
Pension funds
While savings and investments are a suitable way to prepare for retirement, they may not be enough. For additional pension money, pension funds can be useful. They are a long term investment that gives a steady inflation adjusted payout on maturity.
Aggressive funds
The goal of an aggressive growth fund is to deliver steep returns on investment by navigating the more volatile elements of the market. These are suitable for young investors or those who have some amount of disposable funds that they do not really need.
Open Ended Mutual Funds
In open-ended mutual funds, you can exit the fund at your convenience at the current Net Asset Value (NAV) without paying a hefty exit fee. Open-ended mutual funds may choose not to take new investors if the fund size becomes difficult to manage.
Closed Ended Mutual Funds
Closed-ended mutual funds on the other hand have a pre-defined initial investment value that is split into a set number of units. In certain cases, closed ended mutual funds may have investment deadlines for new investors to invest before the fund begins operating. There is a clearly defined maturity period, giving greater stability to the fund and more clarity to investors.
Learn more about how to choose mutual funds in India!
- The different types of mutual funds in India are divided based on asset classes, risk profiles, investment horizons, goals, entry and exit protocols and the size and nature of the securities these funds invest in.
- Risk and reward are inherently tied together. Very high-risk mutual funds have the potential to generate better returns whereas low-risk mutual funds generate lower returns.
- The advantages of mutual funds come from the fact that investors both large and small can come together to form a larger investment fund that gives every participant the benefits of reward and risk management at a larger scale.
- Understanding your goals before choosing from the types of mutual funds available to you helps you make a more informed investment decision.
- Think about the investment horizon that you are comfortable with before making an investment decision. If you are expecting cash crunches in your future, there are many short-term investment options to consider.
