What’s the first thought that comes to your mind when you hear the word Mutual Funds?
Thanks to frequent advertisements, you’re probably hearing a voice in your head speaking at top speed and saying, “Mutual Fund investments are subject to market risks. Read all scheme related documents carefully before investing.”
So, you’ve heard about Mutual Funds and that they are subject to market risks but there’s got to be more, right?
While most people know about the existence of Mutual Funds, not everyone is aware of the different types of Mutual Funds and how each of them work. This article aims to help you understand Mutual Funds a little better.
What are Mutual Funds?
Mutual Funds act in the form of a Trust or an Asset Management Company that manages a pool of money collected from various investors. It invests this money in various types of assets in order to achieve certain financial goals. In other words, Mutual Funds act as trusts which pool the savings of investors, reinvest them in funds to earn profits and then distribute the dividend earned among the investors. In return, the Asset Management Companies charge a certain amount as fees for this service.
Every Mutual Fund is launched with a specific objective and investors who share a similar objective can invest in that particular scheme. Each scheme is managed by a Fund Manager with the help of his financial analysts who keep a tab on the market performance and invest the funds accordingly.
Additional reading: Decoding Mutual Funds
Types of Mutual Funds
Depending on the time of closure, Mutual Funds are divided into two major categories—open ended or close ended. As the name suggests, open ended schemes do not have a specific date when the scheme will be closed, and the ones which have a specific tenure are known as close ended schemes.
Types of Open Ended Schemes
Open ended schemes are further divided into the following categories:
- Debt/Income: In a debt/income scheme, a major part of the funds are invested in debentures, gilt funds, government securities and other debt instruments. This is a low-risk return investment option which is ideal for investors with a steady income.
- Money Market/Liquid: Investors looking to utilise their surplus funds can invest in these short-term investment options, which provide reasonable returns to investors.
- Equity/Growth Funds: Equity investments are popular forms of Mutual Funds among retail investors. These investments are subject to high-risks in the short term, but investors can expect a high capital appreciation in the long run. If you are looking for long-term benefits and are open to taking risks, growth schemes are ideal investment options for you.
- Index Scheme: These investments replicate the movement of benchmark indices like Nifty, Sensex, etc. So these investments are made as per the market conditions and movements.
- Sectoral Scheme: These funds are invested in a specific sector like IT, infrastructure, pharmaceuticals, mining, etc. or segments of the capital market like large-cap, mid-cap, etc.
- Tax Saving Schemes: As the name clearly suggests, this Mutual Fund scheme offers tax benefits to investors. The funds are generally invested in equities offering long-term growth opportunities. Tax saving Mutual Fund schemes typically have a 3-year lock-in period.
- Balanced: This Mutual Fund scheme allows investors to enjoy growth and income at regular intervals as the funds are invested in equities and fixed income securities. This is ideal for the cautiously aggressive investor, as they can enjoy good returns and growth options simultaneously.
Types of Close-Ended Schemes
You can invest in a close-ended scheme only when it is initially launched. This is known as the New Fund Offer (NFO) period. These Mutual Funds have a fixed period of maturity.
- Capital Protection: These schemes are mainly aimed at protecting the principal amount while trying to deliver reasonable return to the investors. Funds are invested in high-quality fixed income securities with marginal exposure to equities which have a fixed maturity period.
- Fixed Maturity Plans: As the name suggests, these are Mutual Fund schemes with a defined maturity period. These schemes do not have any kind of active trading involved and hence the returns are little less when compared to actively managed schemes.
Apart from these open-ended and close-ended schemes, there are Interval Mutual Funds, which operate as a combination of open and close-ended schemes. These schemes allow investors to trade units at pre-defined intervals.
When it comes to selecting a Mutual Fund scheme to invest in, it completely depends on your risk appetite, returns, growth, income and stability. So think about it carefully and make a wise decision!