Mutual Funds

Heard the term Mutual Funds but not familiar with what they actually are? Mutual funds have emerged to be the most popular investment form for any and every type of investor. Due to the simplicity offered, the mutual funds market has witnessed a multi-fold increase in financial terms. Suitable for beginners as well as proficient investors, they are surely a powerful and effective mechanism for all.

Here is a brief guide to understanding the concept of mutual funds as your best investment plan.

What are Mutual Funds?

A mutual fund is an easy investment security option that facilitates the investors to pool in their hard earned money together into a professionally managed and controlled investment. By investing in mutual funds, an investor can indirectly invest in stocks, bonds or cash individually or a combination of all these assets. The underlying security types are generally known as holdings that combine together to form one mutual fund and is generally known as a portfolio.

In simple terms, mutual funds are investment baskets that hold different types of bonds, stocks or a combination of both bonds and stocks. While investing in this investment basket, the investment does not hold the holdings directly rather they own the representation of the holdings. Due to the diversity, mutual funds offer, they are also referred to as diversified investments. Mutual funds assure reduced risk as compared to other individual stocks or bonds.

Why Mutual Funds?

Following four words, best describes the advantages offered by Mutual Funds:

  • Simplicity – Especially for those, who are naïve to the concept of mutual funds, simplicity offered by mutual funds is bliss. Those who have extensive knowledge about stocks and stock market are well versed in creating and managing their portfolio however for those who are short on relevant knowledge, prefer a simple and effective medium. Investing in mutual funds allows the investors to professionally manage their investments even when they do not have knowledge about investing concepts and strategies.
  • Diversity – As an investor, whether you are a beginner or a pro, you would not acknowledge putting all your money in one basket. But managing a diversified portfolio is not everyone’s cup of tea. To fulfil your investment diversification needs, mutual funds are the perfect option to invest in. By pooling in diverse holdings in one basket, mutual funds lets the investors have a diversified portfolio without having to invest in different bonds and stocks individually.
  • Versatility – Mutual funds offer versatility in terms of having access to almost every industry segment. Further, it also allows access to various other asset types like gold, oil and other natural resources. This lets an investor create, manage and grow his/her portfolio with ease and in no time, you can become a proud owner of a high return versatile investment portfolio.
  • Accessibility – The mutual funds market is accessible to all – beginner or pro, risk takers or risk averts, small or big investors and much more. They hold dozens, hundreds or thousands of investible securities with an access to the entire market. This allows the investors to slowly and gradually build their investment portfolio over time.

Types of Mutual Funds

Mutual Funds can be categorised and sub-categorised as below:

  • Based on structure
  1. Open-ended funds – These mutual funds investments are open to be purchased or redeemed throughout the year at the prevailing NAVs. They offer liquidity to the investors since they are not bound by any specific maturity periods i.e. the investors have the option to withdraw their funds at a time of their choice.
  2. Closed-ended funds – These mutual funds investments are available to be purchased only during the initial offer period. They can be redeemed only at a specified maturity date. For liquidity, these are listed to be traded on the stock exchange. Once bought, they can only be sold through trading on the stock exchange at the prevailing share prices.
  3. Interval funds – These mutual funds investments are a combination of open ended as well as closed ended funds i.e. the fund management company opens them for repurchase from the existing unit holders at different time intervals during the fund tenure.
  • Based on asset class
  1. Equity funds – These funds invest in equity stock or shares of different companies and are considered to be high-risk funds. However, they tend to offer high returns as well. These funds generally include speciality funds such as fast moving consumer goods, banking, and infrastructure and so on.
  2. Debt funds – These funds invest in debt instruments like government bonds, company debentures and other fixed income assets. They offer fixed returns and are considered a safe bet.
  3. Money market funds – These funds invest in liquid instruments like CPs, T-bills and so on. They offer moderate returns and are perfect for those investors who wish to park their surplus funds.
  4. Balanced or Hybrid funds – These mutual funds investments invest in a mix of different asset classes i.e. in certain cases, equity proportion is higher than debt and vice versa. Accordingly, the risk and returns vary too.
  • Based on investment objective
  1. Growth funds – Ideal for long time investors, these funds aim at offering capital appreciation by investing primarily in equity stocks. Further, they are risky funds offering higher returns.
  2. Income funds – Ideal for those investors who are looking for capital protection and regular income by investing primarily in fixed-income instruments like debentures, bonds etc.
  3. Liquid funds – Ideal for short term investors who need liquidity with moderate returns by investing in low risk short term or very short term instruments like CPs, T-Bills etc.
  4. Tax-saving funds (ELSS) – These mutual funds investments qualify for deductions under the Income Tax Act and primarily invest in equity stocks. They offer high return depending on funds performance and are high on risk.
  5. Capital protection funds – These mutual funds investments split the investors’ funds by investing in equity markets and fixed income instruments. They ensure the protection of the principal invested by the investors.
  6. Fixed maturity funds – These mutual funds investments invest in money market and debt instruments wherein the maturity date happens to be either same as that of the respective fund or earlier.
  7. Pension funds – Ideal for those investors who are looking for regular income around retirement i.e. the ones who are thinking of a very long term goal. In such investments, funds are generally split between debt markets and equities wherein equities take care of risk and high returns and on the other hand, debts offer low steady returns balancing out the risk.

Based on speciality

  1. Sector funds – These mutual funds investments invest in any specific market sector like infrastructure funds invest in infrastructure sector companies and so on. The returns depend on the respective sector’s performance and the risk involved depends on the nature of the market sector.
  2. Index funds – These funds invest in instruments representing any particular index on a stock exchange that mirrors the index movement as well as returns like purchasing shares that represent BSE Sensex.
  3. Fund of funds – These funds invest in other mutual funds and the respective return depends on the target fund’s performance. They are also referred to as multi manager funds which are relatively safe due to investing in a mix of mutual funds.
  4. Emerging market funds – These funds invest in developing countries with good future prospects. They are high risk investments since they depend on the country’s dynamic economic and political situations.
  5. International funds – Also known as foreign funds, these let the investors invest in international companies of emerging economies except the buyer’s own country companies.
  6. Global funds – They are just like international funds but the only difference is that the buyer can invest in companies of his/her own country as well.
  7. Real estate funds – As the name suggests, these funds invest in the real estate sector companies that can be realtors, property management companies, builders and also companies that provide loans. The investment here can be done in any project i.e. projects that are in the planning phase or partially completed or actually completed.
  8. Commodity focused stock funds – These mutual funds investments invest not in commodities directly but in the companies that are connected to the commodities market like mining companies or commodities producers. Their performance can be the same as the performance of the related commodity.
  9. Market neutral funds – These funds do not invest in the market directly however they invest in ETFs, treasury bills and securities with a fixed and steady growth.
  10. Inverse/leveraged funds – Unlike traditional mutual funds, these funds give you earnings when the market falls and give you losses when the markets perform well. They are high risk instruments suitable for those who are willing to take the risk and incur heavy losses for huge earnings as well.
  11. Asset allocation funds – These funds come in two variants i.e. target date fund and target allocation fund. They allow the fund managers to adjust the allocated assets for achieving results. In such funds, the invested amount is split and invested into various instruments like equity and bonds.
  12. Gilt funds – These are the funds wherein the money is invested in government securities for a longer duration or long term. They are considered to be risk free since the investment is in government securities and are ideal for risk averts.
  13. Exchange traded funds – These funds invest in both open-ended and closed-ended mutual funds that are traded on the stock exchanges. They offer high liquidity as they are managed passively with lower service charges.
  • Based on risk
  1. Low risk funds – Ideal for those who are not willing to take risk therefore their money is invested in safer options like debt market for a longer term. Since the risk involved is less so the returns also tend to be low like gilt funds where funds are invested in government securities.
  2. Medium risk funds – These are ideal for those who do not mind taking some risk to gain higher returns in order to build their wealth over a long period of time.
  3. High risk funds – Ideal for the risk takers looking forward to build their wealth in no time like in the case of inverse/leveraged mutual funds.