What are the different types of mutual funds?

The benefits of investing in mutual funds are several, and it's safe to assume that you now understand the its ins and outs. Agents dealing with mutual funds often use complicated terms which are difficult to comprehend for many of the investors. To make things simple we have discussed the basics of mutual funds, their quick history, different types of mutual funds and why investors should pick them.
Several advantages make mutual funds one of the best investment options. A mutual fund is a tax efficient, simple and efficient tool to secure your investments.

So, before getting into the main topic we must discuss the basics of Mutual Funds.

Mutual funds basics

A mutual fund is a professionally managed investment vehicle, which pools the savings of many investors like you and me and invests them in instruments such as stocks, securities, bonds, and similar assets. Mutual funds are mainly managed by money managers with sufficient knowledge for efficiently investing your money. If you are invested in any mutual fund, you with your fellow investors will face the same fate of the fund. The money managers of a mutual fund invest in a wide amount of securities, and its performance is tracked meticulously. Mutual funds offer you a wide variety of schemes - equity schemes, fixed income schemes, money market schemes, hybrid schemes, ETFs etc.

History of mutual funds in India

It's been a quite a while since mutual funds have come into existence in India but many of us remain unclear about how they work. The first mutual fund was started in India back in 1963, with the formation of Unit Trust of India (UTI). UTI was started by the Reserve Bank of India and Government of India. The objective was to attract small investors and introduce them to market investment. Now, over half a century later, many sorts of mutual funds have penetrated India’s financial markets. Let’s take a closer look at them.

Common types of mutual funds

Mutual funds can be of many types and schemes. Each type of fund can have a different approach such as growth, dividend payout and dividend re-investment.

Following are the types of mutual funds:

1. Debt funds:
   Debts funds are called so since they invest their assets into debt instruments - or instruments that involve borrowing - such as bonds and government securities.
   You get a fixed interest after a fixed amount of time. These are low-risk funds and are suitable if you are not willing to take a risk in the volatility of the stock market.
2. Fixed Income funds:
   These funds commit to deliver regular returns over a period of time. Fixed Income funds can give you a large amount of returns in the long term and are somewhat similar to debt funds. If you’re on the lookout for low-risk funds which can assure you good returns in the long term, this is a perfect fund for you. You will also get a higher dividend than growth funds.
3. Equity funds:
   These are the funds which invest your money exclusively in the stock market. They pose a higher risk compared to other categories of funds. But in the stock market, as with anything else - higher risk brings with itself potentially high returns. Not only do they promise you high returns in long-term investments, they also have lesser tax liability in the long term as compared to debt funds. You can have various types of equity funds:
   • Thematic funds: Thematic funds are often mistaken to be sector funds. But they are fairly different from sector funds. The main objective here is to deliver you optimal results by investing your assets in stocks which belong to a particular theme. The theme could vary from multi-sector, international exposure, commodity exposure etc., unlike a sector fund, theme funds have a broader spectrum to operate in. These funds are risky in nature so it is recommended to invest 10-12% of your existing portfolio. For example: Gold Fund, Emerging Economies.
   • Small cap funds: Small cap mutual funds typically have the highest growing potential. But they are not as stable as large-cap and mid-cap funds. You can invest in small cap funds if you want to invest in small-cap space and possess high risk taking capacity. Holding them for a long term can be fruitful. But you must be aware of the fact that these funds are more than large-cap funds and mid-cap funds in terms of vulnerability to economic and business downturn.
   • Mid cap and large cap funds: Mid cap and large cap funds typically are much safer bets than small cap funds as they are invested in companies which are already established. They will provide you with higher dividend and bonus frequently. But, you cannot expect them to grow as much as small cap funds.
   • Sectoral funds: These are the funds which are confined under a predefined sector. You can invest in these funds if you are confident about a particular sector such as technology, finance, power, etc. Since these funds invest in a particular sector, these schemes are more risky than general schemes but can give you tremendous results if that particular sector grows. For example: Pharma, Banking, Information technologies, Infrastructure.
   • ELSS/Tax-saving funds: The sole purpose of many investors is to save tax. You can save tax by investing in tax-saving schemes like the Equity Linked Savings Scheme (ELSS) to get tax rebates. However, there is a limit of Rs 1.5 lakh for this purpose. These funds have a lock in period of 3 years hence you are not allowed to sell or transfer these funds for 3 years. ELSS funds are eligible for the tax exemption U/S 80 c of Income tax Act.
4. Index funds:
   Index funds invest your money in a collection of stocks to recreate the index they are trying to emulate - such as Nifty or Sensex. Every index consists of many stock participants. You cannot invest directly in an index. So, to earn money as much as the index, you can opt for index funds.
5. Balanced funds (Hybrid funds)
   As the name suggests, the sole purpose of this type of fund is to create a balance between risk and return. Fund managers or AMCs invest your money in both debt institutions and equities. They are also referred to as hybrid funds. These are a perfect match if you want to get good returns with lower risk.

Let’s take a look at the different approaches used by fund managers to help investors meet their specific financial requirements:

1. Growth funds: Growth funds aren’t an entirely separate category of funds. Instead, they are a characteristic that can apply to other funds - such as equity funds. A Growth Fund’s main purpose is to maximise the value of your investment.The main goal of the growth approach is capital appreciation. These funds will offer you lower or even zero dividends but can give you a higher return than Fixed Income Funds.
2. Dividend Funds: Dividend Funds offer investors their returns in the form of dividends that translate into periodic monetary earnings on the part of the investor. This money may or may not be reinvested back into the funds, as per the decision of the investor.. The dividend earned is also usually tax free.

You can easily invest in mutual funds these days. You just need to choose a mutual fund and open a demat account OR give a call to your broker. Some brokers have their own online mutual funds platform as well to help you choose the right mutual fund for you.