Picking a mutual fund to invest in is not an easy decision. There are a variety of mutual fund schemes available that invest in various asset classes and serve short-term and long-term investment objectives of investors. A key thing to note here is: not all mutual fund schemes are the same, nor do they all have similar financial objectives.
Often, investors fail to understand the nuances which distinguish a scheme from another. This results in unprofitable investments. To avoid this, it is important for investors to understand various types of mutual fund schemes before investing in them.
Mutual funds can be categorised on the basis of a number of factors including the duration of investment, the investment objective and the asset class they invest in. Here is the low-down on the various factors:
- Maturity Period or structure
Mutual funds can be divided into three types if we consider the structure of a mutual fund as a deciding factor. These are: Open-ended, close-ended and interval funds.
Open-ended funds are schemes that do not have a maturity date. They remain open for subscription round the year and investors can also exit at their will. Units are allotted at the prevailing net asset value. There is no limit to how much money an investor can invest in the units of such schemes.
Close-ended funds, on the other hand, have a clearly-defined maturity date. Investors can buy units in a new fund offer. Units are listed on stock exchanges and investors can sell them on the stock exchange if they want to exit before maturity.
On the date of maturity, units are redeemed and cash is paid to investors. In some cases, by following a process and after seeking approval from the regulator, close-ended schemes can be converted into open-ended schemes.
Interval funds are schemes that share the characteristics of both open-ended and closed-end schemes.
- Investment Objective
Based on investment objectives, there are five main categories of mutual fund schemes. These include-
Growth funds’ primary aim is to provide capital appreciation in the medium to long-term. A number of schemes thus come under the umbrella of ‘growth schemes or growth-oriented funds’. These schemes primarily invest in stocks and related instruments. Investors may see returns that beat inflation but they may also have to live with volatility in the short term. These schemes work best for investors who are trying to fund their long-term financial goals. Most equity schemes fall in this category.
Income schemes aim to generate regular income from their investments. These schemes invest in corporate bonds, debentures, government securities, money market instruments and other fixed income investments, in most cases. Many debt funds fall in this category. These are less volatile than their equity (or growth) counterparts. However, they are exposed to risks such as credit and interest rate risks since investments are made in fixed income avenues. Investors keen on less volatility and stable returns invest in such schemes.
Tax saving schemes help investors save on income tax. An investment in the units of these schemes fetches tax deduction subject to the rules prescribed in the Income Tax Act. Units allotted in these schemes have a lock in period.
Liquid funds are schemes known for the high liquidity they offer to investors. Liquid funds and overnight funds invest in very short-term fixed income instruments. These schemes are an ideal short-term parking space for investors’ money. The Securities and Exchange Board of India (SEBI) has also allowed mutual fund houses to offer instant redemption facilities in both liquid and overnight funds.
Capital Protection Oriented Funds aim to protect capital and earn some returns for investors. They are termed as capital protection oriented funds. They have a finite term. The capital of a scheme is split between stocks and bonds. They are structured in such a way that the investments in bonds grow over the tenure of the scheme to the extent of the original capital. The money allocated to stocks brings in some returns. The objective is to protect the capital and not to guarantee returns.
- Asset Class
Basis the asset classes invested in, there are three types of mutual funds.
Equity Funds which invest in stocks and related instruments of companies. These schemes tend to generate returns that are expected to beat inflation in the long-term. Equity funds are further classified into large-cap, mid-cap, small-cap, and large-and-midcap funds. There are other categories such as dividend yield, value funds, and thematic funds which fall under the broad spectrum of equity funds. Some equity funds invest in domestic stocks while some invest in stocks listed overseas. Some schemes are structured as a fund of funds that invest in units of other equity schemes. Investments in the units of equity funds may see some volatility in the short-term. Many investors prefer to invest in these schemes using a Systematic Investment Plan that helps stagger investments and thereby, avoid the risk of investing all the money when markets are at their peak.
Debt funds invest in various fixed income securities. They are less volatile as compared to equity funds. They are further sub-divided into categories such as government securities funds, overnight, liquid, ultra-short duration, short duration, medium duration, long duration funds.
Hybrid fund schemes invest in a mix of stocks, bonds or gold. The investment goal of these schemes is to provide both growth as well as income to the investor. Some of these invest in only equity and debt in varying proportion. Some also add gold to their asset allocation. Some manage their asset allocation by using a valuation model and in some cases the asset allocation is static.
Gold Funds are those schemes that invest in gold. In India, most of these schemes are available under exchange traded funds format. Investors need a demat account to buy units of gold ETF. Some fund houses offer fund of funds schemes that invest in units of gold ETF. These schemes allow investors without a demat account to invest in the units of gold ETF.
- Other types of Mutual funds
Some funds are actively managed where a fund manager plays a significant role in selecting securities and building portfolios. At the other end, there are passively managed funds wherein a fund manager’s role is limited to mimicking an index. These schemes have no fund manager risk.
Some funds are marketed through distributors and referred to as open-ended funds, whereas some are offered to investors through the stock exchange – they are referred to as exchange traded funds.
How to start investing in mutual funds?
Investing in mutual funds has become easy thanks to the extensive use of technology and ever evolving digital payments infrastructure. Investments in mutual funds can be initiated if you have a permanent account number or PAN and an address proof. These are mandatory requirements to complete the know-your-customer (KYC) process.
An investor only needs to carry out the KYC once, before their first investment. There is no need to repeat it for all the future investments. You can complete the KYC process online using the AADHAR based e-KYC or you can also approach a fund house, a mutual fund distributor or a registered investment advisor to help you with the process.
You can transact in units of mutual funds offline as well as online. Mutual fund distributors sell mutual fund schemes. Online mutual fund distribution platforms and brokers can also be tapped to transact in units of mutual funds.
Once you are done with your KYC, you can start investing in various mutual fund schemes. If you are keen to handle your investments on your own, you could do so. Otherwise, you can also seek advice from investment advisors.