What are mutual funds?
Mutual funds are pool of money gathered from different investors and combined together to be invested in different types of securities like stocks, money market instruments, bonds, and other related assets. Professional experts called fund managers manage mutual funds that are operational in allocation the money from investors in these different assets depending upon their market cap, risk profile, return profile and in their best capability to generate maximum returns. The portfolio building of a mutual fund generally is done keeping in mind the investment objective of the portfolio and interests of investors.
Types of mutual funds
Mutual funds are categorized broadly in 5 categories based on:
- Asset class
- Investment goals
- Specialization or specialized mutual funds
Mutual fund types and their meaning
Based on structure
- Open-ended funds: These are those funds that provide the highest flexibility to the investor. From choosing as many funds as they want to enter and exit anytime, open-ended funds are the most convenient fund type. The entry and exit can be done based on the particular day’s Net Asset Value.
- Closed-ended funds: In closed-ended funds, the unit capital which is to be invested is pre-determined and fixed before trading starts. The fund houses and companies cannot sell units more than the fixed number. NFO or New Fund Offers also fall under the same category of closed-ended funds and have a timeline set to welcome buyers.
- Interval funds: Interval funds are a mix of both open-ended and close-ended funds which are accessible only at certain intervals for both entering and exiting purposes which are decided by the concerned fund house.
Based on Asset Class
- Equity funds: Equity funds are those which invest primarily in stocks and other equity-related assets. The money pooled by investors is pushed into the stock market by investing in shares of different companies diversified across different sectors.
- Debt funds: Debt funds are those which invest in fixed income securities like treasury bills, bonds, gilt funds, fixed maturity plans, liquid funds, short term plans, etc. most of the asset class under this segment has a fixed maturity over a fixed rate of return.
- Money market funds: Money market is also known as the capital market or cash market. The money market is also traded like the stock market. Certificates of deposit, treasury bills, etc are a part of money market trading.
- Hybrid funds: Hybrid funds are the ones that are a combination of equity and debt funds and are a perfect investment option for investors who are looking forward to a mixed portfolio type. The distribution of funds is done as per investor’s needs and risk and return profile.
Based on investment goals
- Income funds: These are for investors who wish to get a regular income as they invest their money. The money is invested in a mix of securities and fall under debt funds.
- Growth funds: These are for investors who have spare money to be invested in plans which are a little higher on the risk side and returns as well.
- Liquid funds: These are also debt funds which invest in securities that are highly liquid maturing within 91 days.
- Tax saving funds: ELSS funds are both tax-savers as well as return generators with a lock-in of 3 years.
- Aggressive growth funds: These funds are best suitable for aggressive investors who can play their money and generate extraordinary returns.
- Capital protection funds: Coming with little smaller returns of up to 12%, these funds are best suitable for investors who are looking forward to capital preservation with minimal returns.
- Fixed maturity returns: FMP are for risk-averse investors who are too critical of the market movements and come with a fixed tenure ranging from 1 month till 5 years.
- Pension funds: Investors who want to secure their retirement financially go for pension funds. EPF and NPS is an example of pension funds.
Based on risk
- Very low-risk funds: Funds that have a short or ultra-short tenure and come with comparatively lower returns fall under this category. Best for short and ultra-short-term goals and capital preservation
- Low-risk funds: These funds provide a little better return that the ultra-short-term funds and allow switching to better performing funds through STP as the market improves.
- Medium risk funds: Best for investors with moderate risk appetite, the risks, and returns fall in the middle of the spectrum. The returns range between 9% to 12%.
- High-risk funds: Risk-friendly investors go for these funds and are highly rewarded. The returns may range between 15% to 20% and up to 30%.
Specialized mutual funds
- Index funds: Index funds are the ones where the investor’s money is put in the index and are best suitable for passive investors. Index funds simply replicate the index they follow. Good for passive investors.
- Sector funds: Sector funds allow theme-based investment in a specific sector which are high performing. The investor needs to time the market while investing in sectoral funds.
- Funds of funds: funds of funds are investing in a particular fund which is further invested in many other funds.
- Foreign funds: Investing your money in foreign mutual funds brings out better reruns and investment opportunities. You can always go for a mix of domestic and international investment to cushion the risk and elevate the returns.
- Global funds: differentiating from foreign funds on the lines that in global funds you also invest in your home country as well
- ETFs: Exchange-traded funds belong to index fund families and traded over exchanges.
Selecting mutual funds to invest in
Now that you have understood mutual fund meaning and types, picking a mutual fund to invest in is the next step.
Picking the right mutual fund is very crucial to the health of your investment portfolio. Investing in the right funds at the right time is the key to success. Every year there is a list of well-performing funds based on past years, under each category of funds, which you can consider investing in according to your investment needs. For instance, under Sundaram mutual fund you can select Sundaram Select focus Mutual fund if you are looking for long term capital appreciation, or among kotak mutual fund, you can go for Kotak large and mid-cap opportunities fund if your investment horizon is more than 5 years etc. for the best performing mutual funds.