What are Mutual Funds?
Mutual funds have been gaining popularity in the past few years as an effective method of investment. Mutual funds act as an alternative investment option where many investors have their money collected together to invest in securities like stocks, bonds and other assets. Professional money managers allocate the funds in order to create capital gains for the investors.
Mutual funds work as an investment option through which small or individual investors have access to diversified and professionally managed portfolios at a low price.
The most popular types of mutual funds are listed below:
- Equity Funds
- Debt Funds
- Money Market Funds
- Index Funds
- Balanced Funds
- Income Funds
- Funds of funds
- Specialty Funds
Equity funds are usually invested in the stocks /shares of the companies. The fund manager usually tries to spread the investment across companies from different sectors or with varying market capitalization. They are considered as high-risk investments but they also tend to provide high returns since their performance depends on the market conditions.
Equity funds are classified as the funds invested in the company size and growth prospect of the invested fund. They are small-cap, mid-cap, and large-cap companies.
Small-cap stock refers to those stocks with a market cap ranging from $250 million to $2 billion. Large-cap companies have high market capitalization with values over $10 billion. Mid-cap stocks fill the gap between small and large-cap.
A debt mutual fund is also known as a fixed-income fund because a significant portion of your money is in fixed-income securities like government securities, debentures, corporate bonds and other money-market interments. Debt mutual funds lower the risk factor for investors, which helps them generate some amount of wealth. This means that these funds usually earn interest income on the money that was invested, similar to how a Fixed Deposit works.
Different types of Debt Funds:
Liquid Funds: This type of fund is invested with a maturity period of 91 days. Investors can withdraw up to Rs.50,000 at an instant from some liquid funds. These funds are considered the least risky among the mutual funds.
Short/Medium/Long Term funds: Short-term debt funds come with a maturity period of 1-3 years. These types of mutual funds are suited for investors that have a low-risk tolerance.
Medium-term debt funds come with a portfolio maturity period of 3-5 years and long term debt funds come with a maturity period beyond 5 years. Medium and long term debt funds are riskier because the duration is longer, which has a larger impact on interest rates on the portfolio.
Dynamic bond funds: In dynamic bond funds, the fund manager changes the maturity depending on their prediction of interest rates. If the prediction of the interest rate is rising, the maturity period is shorter. If the prediction of the interest rate is falling, the maturity period is extended. The maturity period in these funds is always fluctuating.
These funds are slightly riskier than short debt funds.
Fixed Maturity Plans: Fixed Maturity Plans or FMPs have a lock-in period. You can invest in the initial offer period but cannot make further investments in this scheme. Many investors consider FMPs similar to an FD but FMPs do not promise fixed returns. However, FMPs are more tax-efficient than FD.
Money Market Funds
Money Market Funds are debt funds that are lent to companies for a period of 1 year. The funds are designed in a way that allows the fund manager to generate wealth while keeping the risk under control by adjusting the lending period. High loan tenure usually comes with higher returns. The ideal investment period would be around 3-6 months. There are low chances of loss if someone stays invested for more than 6 months. This scheme tends to give better returns than Bank Fixed Deposits.
Index Funds are becoming very popular these days. Index funds, as the name suggests, are funds invested in an index. They invest the funds in the stocks that constitute the index. Many studies have shown that it is not easy to predict the market and beat it consistently. Why waste time studying the stock when you can invest in an index to save time and money? After all, frequent trading also involves paying various charges. Investing in index funds is extremely popular in developed countries. Investors invest in low-cost index funds to take care of their long-term financial goals.
Balanced Funds are the new category of mutual funds that came into existence after SEBI (Securities and Exchange Board of India) re-categorized mutual funds in 2017. Balanced Funds are also referred to as aggressive hybrid funds by fund managers, fund advisors and investors. As per SEBI, balanced funds have the option to invest 40-60 % of the corpus fund in equity and 40-60% in debt. For example, A person has the option to invest 60% in stock and 40% in debt. The mixed portfolio of equity and debt makes this a safer option of investment than pure equity funds. The debt part of the portfolio offers stability while equity would help investors to earn little extra returns.
Income Funds are mutual funds that regularly provide a source of income. The mutual funds are invested in a mixture of diverse assets such as certificates of deposits, Government securities, money market interments and corporate bonds. The fund managers give priority to assets that have high-interest rates that give great dividend benefits. Compared to Bank Fixed Deposits, Income funds accumulate more returns within a short period. However, there is no guarantee of fixed or assured returns. Income funds offer high flexibility and liquidity in terms of investing and withdrawing money. It ensures that the investor enjoys regular cash flow. Another advantage of an income fund is that it has tax benefits, especially for those who fall under the 30% or 20% income tax bracket. Capital gains held over 1 year are taxed without indexation at 10%.
Funds of funds
Funds of funds is a mutual fund scheme that invests in other mutual funds. Just as mutual funds are invested in stocks and bonds, Funds of funds invest in other mutual funds schemes. The fund manager holds a portfolio of other mutual funds instead of directly investing in equities and bonds. These funds are advantageous to investors with a small amount of funds available each month. The diversification of funds helps reduce risk. They are tax friendly to investors with limited capital. Funds of funds require the background of their managers to be checked and verified so you can be assured that a trustworthy person handles your funds.
Specialty Funds are also known as sector funds that focus on a specific industry or market. Sector funds give you access to a small part of the overall market such as energy, health care or real estate for example. Due to their narrow focus, they offer less diversification, which means they come with higher potential risk. These types of funds are considered ideal for aggressive investors having high-risk appetite. Investors choose sector funds when they expect a particular sector or industry to outperform the overall capital market.
Mutual funds are one of the simplest ways to invest and achieve your financial goals on time. But before you invest, it is important that you do your research and explore every fund option. Don’t invest in a fund because a colleague or friend has invested in it. First, identify your goals and invest accordingly. If required, you can approach a financial advisor to help you make the right investment decision. Goodwill offers such support for mutual funds. You can start investing in mutual funds using Goodwill and its professional financial advisors. We offer free training programs and free of charge for opening a Demat Account. Start your investment journey right away!