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Considering diversification for your investments? Various mutual fund options are available to suit your needs. These funds can be classified based on factors such as asset class, investment objectives, and risk levels.
In this article, we explore the different types of mutual funds available in India and the advantages they provide.
Types of Mutual Funds
Before investing in mutual funds, it’s crucial to grasp the various types available and the benefits they offer. Mutual funds can be categorised based on several factors.
1. Based on Asset Class
Equity Funds
Equity funds, also known as stock funds, invest primarily in stocks. They pool money from multiple investors to purchase shares of various companies. The performance of these funds is directly linked to the stock market’s fluctuations, offering the potential for high returns along with higher risk.
Debt Funds
Debt funds focus on fixed-income securities like bonds, treasury bills, and other debt instruments. They are ideal for passive investors seeking regular income with minimal risk, as these investments typically provide a fixed interest rate and maturity date.
Money Market Funds
Money market funds invest in short-term, high-quality investments issued by governments, banks, and corporations, such as T-bills and certificates of deposit. These funds aim to offer a low-risk investment option with regular dividends and are suitable for short-term investment horizons.
Hybrid Funds
Hybrid funds, or balanced funds, combine stocks and bonds in varying ratios to balance risk and return. They offer a mix of equity and debt investments, making them suitable for investors seeking higher returns than debt funds with less risk than pure equity funds.
2. Based on Investment Goals
Growth Funds
Growth funds focus on investing in shares and growth sectors. They are ideal for investors, especially Millennials, who have extra money to invest in higher-risk plans with the potential for significant returns.
Income Funds
Income funds are a type of debt mutual fund that invests in a mix of bonds, certificates of deposit, and other securities. Managed by experienced fund managers, these funds aim to provide better returns than traditional deposits, making them suitable for risk-averse investors with a 2–3-year investment horizon.
Liquid Funds
Liquid funds invest in short-term debt instruments and money market securities with a maturity of up to 91 days. Unlike other debt funds, their Net Asset Value (NAV) is calculated daily, making them a low-risk option for short-term investments.
Tax-Saving Funds
Equity Linked Savings Schemes (ELSS) offer both wealth growth and tax benefits. Predominantly investing in equities, these funds have a three-year lock-in period and can generate tax-free returns, making them a good choice for salaried investors with long-term goals.
Aggressive Growth Funds
Designed for significant monetary gains, aggressive growth funds are high-risk investments. They tend to outperform the market during uptrends, which is suitable for investors comfortable with market volatility and looking for higher returns.
Capital Protection Funds
These funds prioritise protecting the principal while earning modest returns. They invest in a mix of bonds and equities, recommended for investors seeking low-risk options and willing to stay invested for at least three years.
Fixed Maturity Funds
Fixed Maturity Plans (FMPs) invest in bonds, securities, and money market instruments with a fixed tenure. These close-ended funds are ideal for those looking to minimise tax liability through indexation and prefer investments with fixed maturity periods.
Pension Funds
Pension funds allow you to save a portion of your income for long-term financial security after retirement. These funds are designed to provide financial support during retirement, covering expenses like medical emergencies and other contingencies beyond relying solely on savings.
3. Based on Structure
Mutual funds are also categorised by their structure, affecting the flexibility of trading units. The main types are open-ended, closed-ended, and interval funds.
Open-Ended Funds
These funds allow continuous buying and selling of units at the current Net Asset Value (NAV) without time or unit constraints. The unit capital changes as investors enter and exit.
Closed-Ended Funds
With a fixed number of units, these funds can only be purchased during the initial offer period. They have a set maturity period and offer liquidity through repurchase options or stock exchange listings.
Interval Funds
Combining features of both open and closed-ended funds, interval funds allow transactions only during specified periods. They are suitable for short-term goals, with restricted transactions for at least two years.
4. Based on Risk
Very Low-Risk Funds
Liquid and ultra-short-term funds (with durations of one month to one year) offer low risk and returns, around 6%. They are ideal for short-term financial goals and safeguarding capital.
Low-Risk Funds
During economic uncertainty, investors may prefer low-risk options like liquid, ultra-short-term, or arbitrage funds. These provide returns of 6-8% and offer flexibility to switch investments when market conditions improve.
Medium-Risk Funds
These funds balance risk by investing in both debt and equity, resulting in moderate volatility. They typically offer returns of 9-12%.
High-Risk Funds
Aimed at investors seeking substantial returns and willing to take on significant risk, high-risk funds require active management and regular performance monitoring. Expected returns are around 15–20%, but they are highly susceptible to market fluctuations.
5. Specialised Mutual Funds
These mutual funds focus on specific industries or strategies:
Sector Funds
Sector funds invest exclusively in one sector, making them a higher risk due to limited diversification. They can offer great returns, especially in booming industries like banking, IT, and pharma.
Index Funds
Ideal for passive investors, index funds replicate a market index by investing in the same stocks and proportions. They aim to match market performance rather than outperform it.
Funds of Funds
These invest in multiple mutual funds rather than individual stocks or bonds, offering diversification at a lower cost by pooling various fund categories into one investment.
Emerging Market Funds
Investing in developing markets, these funds are risky but have the potential for high returns. They are susceptible to market fluctuations but can contribute significantly to long-term global growth.
International/Foreign Funds
These funds invest in markets outside India, providing returns even if domestic markets underperform. Investors can adopt hybrid, feeder, or theme-based approaches to diversify internationally.
Global Funds
Global funds invest worldwide, including in the investor’s home country. They offer diversification but carry risks due to varying policies, markets, and currencies.
Real Estate Funds
These funds invest in established real estate companies or trusts rather than directly in property projects, offering a way to participate in the real estate market with reduced risk and increased liquidity.
Commodity-focused Stock Funds
Ideal for investors with a high-risk tolerance, these funds invest in commodity-related businesses. Returns depend on the performance of the commodity or the associated companies, with gold being the only direct commodity investment allowed in India.
Market Neutral Funds
Designed to hedge against market downturns, these funds aim to deliver steady returns by balancing long and short positions, allowing investors to outperform the market with lower risk.
Inverse/Leveraged Funds
These funds move opposite to the benchmark index, allowing investors to profit from market declines. They involve selling stocks when prices drop and buying them back at lower prices.
Asset Allocation Funds
Combining debt, equity, and sometimes gold, these funds adjust their investment mix based on market conditions. They offer flexibility and require skilled management to balance assets effectively.
Gift Funds
Mutual funds or Systematic Investment Plans (SIPs) can be gifted to secure the financial future of loved ones.
Exchange-traded Funds (ETFs)
Similar to index funds but traded on exchanges, ETFs offer real-time trading and provide exposure to international markets and specialised sectors. They are bought and sold like stocks, with prices fluctuating throughout the day.
Tax benefits under Section 80C of the Indian Tax Act allow for deductions up to ₹150,000 from total annual income.