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What is Mutual Fund & Types of Mutual Funds in India

Updated on: 12 Jun, 2024 03:13 PM

Mutual fund investments are one of the best investment avenues in today’s time. They let you invest as per your risk profile, diversify your investments into different types of assets, and give you the best possible returns. Moreover, if you choose tax-saving mutual fund schemes, you can also save taxes on the money that you invest. One of the major factors that make mutual fund investments one of the best is the fact that the fund comes in multiple variants. There are different types of funds to suit the varied investment objectives and risk profiles of different investors. That is why when you look for mutual fund investments, you would get a wide array of choices. And picking the right scheme for your needs requires proper knowledge of mutual funds. This article will help you understand more about Mutual funds, their benefits, and their types.

Types of Mutual Funds Based on Their Asset Class

Mutual funds can be classified depending on the fund’s asset allocation. Based on the assets in which the fund invests, mutual fund schemes can be of the following types –

Equity mutual funds

Equity mutual funds are those funds which invest at least 65% of their portfolio in equity and equity oriented securities. Since equity exposure of these funds is high, the fund is exposed to market volatility and has a high risk. However, the returns promised by these funds are also high and the funds are suitable for risk loving or aggressive investors.

Debt mutual funds

Debt mutual funds, on the other hand, invest 65% or more of their portfolio in fixed income instruments and debt securities. Since the securities have fixed returns, the fund has very little risk. The returns promised are low and debt funds are suitable for risk-averse individuals.

Hybrid or Balanced Funds

These funds combine the benefits of equity and debt funds. The investment of the fund’s portfolio is done partly in equity and partly in debt. That is why the high risk associated with equity exposure is balanced by debt investments and the low returns of debt investments are offset by the high returns of equity. Hybrid funds, therefore, have moderate risks and give moderate returns.

Money Market Funds

Money market funds are those funds which invest in money market instruments like bonds, treasury bills, certificates of deposits, etc. The underlying assets of this fund are traded in the money market and hence the name. Moreover, the assets yield interests which are paid back to investors in the form of dividends.

Types of Mutual Funds Based on Structure

There are three types of mutual funds based on their structure. These include the following –

Open-ended mutual funds

Open-ended funds are those which allow purchases any time. You can buy and sell units in this scheme any time that you want. There is no time limit to buy or sell.

Close-ended mutual funds

These mutual funds have a time limit for buying or selling units. The capital which is to be invested in the market is decided beforehand and so these funds issue a specified number of units. Once the units are sold, you won’t be able to buy the funds. Close-ended funds might also launch a New Fund Offer for a limited time period. Even the maturity tenure of the fund might be fixed.

Interval funds

These funds combine the structures of open-ended and close-ended funds. They have a specific window for buying or selling the investment. The rest of the time, the funds are not open for subscription or redemption. When you buy an interval fund, no transaction would be allowed in the first two years.

Types of Mutual Funds Based on the Goal of Investment

The following types of mutual funds are categorized based on the type of investment strategy that the fund managers follow when managing the portfolio of these funds.

Growth funds

Growth funds are those which reinvest the returns generated from their portfolio in the portfolio itself. As the returns are reinvested, the value of the portfolio grows which also increases the Net Asset Value. When you, subsequently, redeem the fund, the units would be redeemed on the increased Net Asset Value generating substantial returns. Growth funds invest primarily in equity oriented stocks and are, therefore, equity mutual funds. They aim at capital appreciation and have a high-risk profile due to equity investments.

Aggressive growth funds

Aggressive growth funds invest in risky securities which also have the potential of yielding the highest returns. These funds are highly prone to market fluctuations and you should invest in them only if you have sufficient risk appetite.

Income Funds

Unlike growth funds, income funds promise regular pay-out of incomes. If you are wondering what is a growth mutual fund, these funds are, majorly, debt-oriented mutual funds that invest in fixed-interest instruments like bonds, deposits, etc. As the interest is earned on the underlying instruments, the interest is paid to the investor quarterly, half-yearly, or annually. Income funds are suitable for those who are looking for regular income from their mutual fund investments.

Liquid funds

Liquid funds are very short-term debt funds that invest in instruments having a maturity period of 1 day to 91 days. These funds aim to provide liquidity and are ideal for parking your surplus funds for a time being. Moreover, liquid funds are a better alternative to keeping money in your bank savings account as these funds promise better returns than saving accounts of banks.

Tax saving funds

As the name suggests, tax-saving mutual funds are mutual funds that aim to save you tax liability. Equity Linked Saving Schemes (ELSS) are the only tax-saving mutual funds available that allow tax benefits on the money that you invest. The investment done in ELSS schemes qualifies for tax deduction under Section 80C up to a maximum of INR 1.5 lakhs. Thus, ELSS funds give you a tax advantage and since they are a type of equity mutual fund, the returns are also good.

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Capital protection funds

Under these mutual funds, the capital that you invest is kept safe. Fund managers invest your money in equity and debt instruments with the objective to protect the invested amount at all costs. While the returns are low, these types of funds come with high safety and security. Capital protection funds also come with a lock-in period of 3 years, during which you cannot withdraw from your investments.

Fixed maturity funds

As is evident from the name, fixed-maturity funds have a fixed date of maturity. These are, therefore, closed-ended mutual funds where the investment period ranges from 1 month to up to 5 years. Fixed maturity funds are a type of debt mutual funds that invest in fixed-income securities. The fund managers of the fund try and invest in instruments that have the same maturity tenure as that of the fund so that at the time of maturity the interest earned from the investments can be passed down to the investors.

Pension funds

Pension funds are mutual funds that invest to create a retirement corpus for your golden years. The fund managers of the fund invest in securities with a long-term investment horizon. Though pension funds are meant to create a fund after retirement, you can withdraw from the fund in advance, too. Redemption of pension funds can be done in one lump sum, or you can also choose to receive regular income from the fund.

Types of Mutual Funds Based on Investment Risk

Mutual funds can also be classified based on the type of investment risk that the fund carries. The following are the main sub-divisions of the types of funds based on their risk profile –

High-risk funds

Equity funds which invest primarily in equity related securities fall under this category. Since the portfolio is invested in equity, it is exposed to market risks and equity and equity oriented mutual funds are called high risk funds.

Medium risk funds

Hybrid or balanced funds, which combine equity and debt investments, are said to have medium risks and fall in this category.

Low-risk funds

Basically, all types of debt funds are classified as low risk funds since they invest in debt which are fixed-income securities. Debt investments are not exposed to market risks and therefore have low risks.

Very low-risk funds

Debt funds which have no investment risk, credit risk or interest rate risk are called very low risk funds. Liquid and ultra-short term debt funds fall in this category since they invest in very dhort tenure instruments.

Other Types of Specialized Funds

There are also mutual funds belonging to specific categories and so they fall under the category of specialised funds. Here are the types of such funds –

Sector-specific funds

These funds invest in a specific sector. The stocks of the companies operating in the chosen sector are bought using the mutual fund assets. Some common sector funds include banking funds, IT funds, pharma funds, etc.

Fund of funds

Under this type of mutual fund scheme, fund managers invest in a mutual fund which, in turn, invests in other funds. This scheme, therefore, diversifies the risk to the maximum possible extent, and the returns depend on the targeted fund.

Index funds

Index mutual funds are passively managed schemes that invest in the stocks of a particular index like the Nifty 50, BSE, etc. The performance of the fund mirrors the performance of the index into which the fund has invested.

International funds

Under international or foreign mutual fund schemes, the portfolio is invested in stocks of international companies operating in other countries for better returns.

Emerging markets fund

These mutual fund schemes invest in developing countries whose economies have a high potential for growth.

Global funds

These are like international funds which invest in securities of international companies operating in different parts of the world. However, in global funds, unlike in international funds, investment can also be made in securities in the Indian market.

Commodity-focused stock funds

These mutual funds invest in commodities or the stocks of companies dealing in commodities. These funds have a high risk profile and are suitable for risk taking investors.

Leveraged funds

These funds have a completely opposite investment approach compared to other mutual funds. Under these funds, maximum returns are generated when the stock market falls and there is a loss in case the market rises.

Asset allocation funds

Under these mutual funds, the fund manager has complete flexibility in choosing the asset profile for the portfolio. The manager can, therefore, choose to invest in equity and debt in any ratio with the aim of generating the maximum returns.

Gilt Funds

Mutual funds that invest only in Government securities are called Gilt Funds. Since the securities carry a fixed rate of returns, these funds have marginally low risks.

Exchange Traded Funds

ETFs are like index funds which track a particular index or a commodity or multiple types of similar assets. These funds can be freely traded on the stock market and facilitate intraday purchases as well.

So, these are the main types of mutual fund investments. Know these types, their asset allocation and their risk profile to choose the most suitable fund based on your investment strategy.

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Frequently Asked Questions

Q- What are direct mutual funds?

Direct funds are those funds which are to be purchased without the involvement of any broker or distributor.

Q- What is SIP?

SIP stands for Systematic Investment Plan, wherein a fixed amount of money is invested in a chosen mutual fund scheme every month.

Q- Can I exit from the mutual fund scheme whenever I want to?

Unless the mutual fund scheme has a minimum lock-in period for investment, you can exit from the scheme whenever you want to.

Q- Can I invest in multiple types of funds?

Yes, you can invest in as many types of mutual fund schemes as you like without limitations. However, ensure that the schemes you choose suit your risk profile and investment goals.

CA Abhishek Soni
CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.