Types of mutual funds
Mutual funds are broadly classified into three categories based on their investment traits and risks involved. Understand all mutual fund types and analyse them to check if your requirements would be served by investing in a particular type of mutual fund. Following are the types of mutual funds:
Equity Funds
Equity funds primarily invest in shares of different companies. Your equity funds investment would make a profit when the share prices surge, while they suffer a loss when the share prices fall. Investing in equity funds is apt for those who stay invested for an extended period and are comfortable with moderate to high risk.
Equity mutual funds invest at least 60% of their assets in equity shares of numerous companies in suitable proportions. The asset allocation will be in line with the investment objective. The asset allocation can be made purely in stocks of large-cap, mid-cap, or small-cap companies, depending on the market conditions. The investing style may be value-oriented or growth-oriented.
After allocating a significant portion towards the equity segment, the remaining amount may go into debt and money market instruments. This is to take care of sudden redemption requests as well as bring down the risk level to some extent. The fund manager makes buying or selling decisions to take advantage of the changing market movements and reap maximum returns.
Features
a. Cost of investment
b. Holding period
c. Cost-efficiency & diversification
Among all categories of mutual funds, equity funds generally deliver the highest returns. On average, equity funds have generated returns in the range of 10% to 12%. The returns fluctuate depending on the market movement and overall economic conditions.
To earn returns in line with your expectations, you need to choose your equity funds carefully. For that, you have to strictly follow the stock markets and possess knowledge of the quantitative and qualitative factors. ClearTax assists by handpicking the top-performing investment portfolios for you, which suits your financial goals.
Benefits of Investing in Equity Funds
The benefits of investing in mutual funds are many:
a. Expert money management
b. Low Cost
c. Convenience
d. Diversification
e. Systematic investments
f. Flexibility
g. Liquidity
Debt Funds
Debt funds primarily invest in fixed income government securities such as treasury bills and bonds, or reputed corporate deposits. Investing in debt funds is less risky than equity funds. Debt Funds are apt for those who are risk-averse and looking for a short-term investment.
When a company or issuing entity wants to raise funds, they sometimes ‘borrow’ from investors. In return, they promise a steady and regular interest to the lender. This is how a debt fund works. In this article, let us explore debt funds in detail.
Buying a debt instrument is similar to giving a loan to the issuing entity. A debt fund invests in fixed-interest generating securities like corporate bonds, government securities, treasury bills, commercial paper and other money market instruments. The fundamental reason for investing in debt funds is to earn interest income and capital appreciation. The issuer pre-decides the interest rate you will receive as well as the maturity period. Hence, they are also known as ‘fixed-income’ securities.
Debt funds invest in different securities, based on their credit ratings. A security’s credit rating signifies whether the issuer will default in disbursing the returns they promised. The fund manager of a debt fund ensures that he invests in high credit quality instruments. A higher credit rating means that the entity is more likely to pay interest on the debt security regularly as well as pay back the principal amount upon maturity.
Debt funds which invest in higher-rated securities are less volatile when compared to that of low-rated securities. Additionally, maturity also depends on the investment strategy of the fund manager and the overall interest rate regime in the economy. A falling interest rate regime encourages the manager to invest in long-term securities. Conversely, a rising interest rate regime encourages him to invest in short-term securities.
Debt funds try to optimize returns by diversifying across different types of securities. This allows debt funds to earn decent returns. However, there is no guarantee of returns. Debt fund returns often fall in a predictable range. This makes them safer avenues for conservative investors. They are also suitable for people with both short-term and medium-term investment horizons. Short-term ranges from 3 months to 1 year, while medium-term ranges from 3 years to 5 years.
a. Short-term debt funds
For a short-term investor, debt funds like liquid funds may be an ideal investment, compared to keeping your money in a saving bank account. Liquid funds offer higher returns in the range of 7%-9% along with similar kind of liquidity for meeting emergency requirements.
b. Medium-term debt funds
For a medium-term investor, debt funds like dynamic bond funds can be ideal for riding the interest rate volatility. When compared to 5-year bank FDs, debt bond funds offer higher returns. If you are looking to earn a regular income from your investments, then the Monthly Income Plans may be a good option.
Balanced or Hybrid funds
As the name suggests, balanced or hybrid funds invest in both equity and debt instruments to balance the risk and maintain a specific rate of return. The fund manager decides the ratio to reap the best of both debt and equity instruments.
Hybrid funds invest in both debt and equity instruments to achieve diversification and avoid the concentration risk. A perfect blend of the two offers higher returns than a regular debt fund while not being as risky as equity funds. The choice of a hybrid fund depends on your risk preferences and investment objective.
Hybrid funds aim to achieve wealth appreciation in the long-run and generate income in the short-run via a balanced portfolio. The fund manager allocates your money in varying proportions in equity and debt based on the investment objective of the fund. The fund manager may buy/sell securities to take advantage of market movements.
Hybrid funds are considered a safer bet than equity funds. These provide higher returns than genuine debt funds and are popular among conservative investors. Budding investors who are willing to get exposure to equity markets may invest in hybrid funds. The presence of equity components in the portfolio offers the potential to earn higher returns.
At the same time, the debt component of the fund provides a cushion against extreme market fluctuations. In this way, you receive stable returns instead of a total burnout that may happen in case of pure equity funds. For the less conservative category of investors, the dynamic asset allocation feature of some hybrid funds becomes a great way to enjoy the best out of market fluctuations.