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What are Mutual Funds?
Mutual Funds are specialised investment vehicles that pool in money from various investors and invest it in various asset classes like Equity, Debt, and International Securities or into schemes that are a mix of these asset classes. Mutual Fund schemes also have specialised products such as Sector specific funds, Large Cap, Small Cap funds etc. Mutual Funds are ideal for those who do not want to park their funds in the market directly due to scepticism or lack of understanding, however they do want to gain from exposure to the market.
Mutual Funds are emerging as one of the most preferred investment options for young professionals. Disciplined savings, stable returns and ease in investing are some of the factors why everyone wants Mutual funds in their portfolio.
Mutual Fund Types
To select the right fund, you need to first know the types of mutual funds available in the market. We have classified the mutual fund types based on the structure of funds and asset class.
There are three types of mutual funds based on their structure. This particularly determines when you can buy and sell the units.
(1) Open-ended schemes: You can buy and sell the units of these Mutual Funds at any time of the year. These funds do not have a fixed maturity period and allows you to invest as long as you want. If you want more liquidity, an Open-ended scheme is for you. These funds are not listed on stock exchange, and they are purchased and redeemed at prevailing Net Asset Values (NAV).
Advantages of Open-Ended schemes:
(2) Close-ended schemes: You can buy these funds only during the initial offer period, and have to hold it till the fixed maturity date. After the initial offer stage, the funds stop issuing units for sale. Close-ended funds are listed on the stock exchange and could be sold at a price different from the NAVs. The market forces of demand and supply determine this price.
(3) Interval Funds: This type of mutual fund is a cross between open and close-ended funds. Interval funds are open for repurchase and redemption at regular intervals during the tenure of the fund. The Asset Management company presents existing shareholders with the option of offloading their shares at intervals if they wish to. These funds may be traded on the stock exchange or may be open during pre-determined intervals at NAV based prices.
Equity Funds invest more than 60% of the assets in listed equities. Rest of the funds are invested in debt securities to balance the risk profile and support redemption. These funds are riskier but generate high-return over a long-term. Here are a few Equity mutual fund types:
This mutual fund type is less risky and invests in debt-market instruments like bonds, debentures, government securities and other fixed income securities. Debt funds can be short-term or long-term. The returns will be in the form of interest income and capital appreciation. Various types of debt funds are:
Hybrid or Balanced Funds are schemes which invest money across asset classes. In some cases, the exposure to equities is more than debt securities, while in other cases it is vice-versa. The rationale behind the allocation of assets is to strike an ideal balance between risk and returns. The Hybrid or Balanced Funds are suitable for investors who are willing to earn that “extra return” apart from what their conventional fixed income security.
Pension funds are a type of mutual fund that are invested for a considerably long period of time. Their primary goal is to provide regular returns at the time of retirement of the investor. The investments in such a fund may be allocated between equities and debt markets. The Equity portion of funds give higher returns while maintain a high exposure to risk, while the debt funds balance the risk element but provide slow and steady returns. The returns from these funds can be availed as a lump sum amount, as periodic pension or a combination of both.
Capital Protection Funds
This is a special type of debt fund which only aims to protect your capital. The returns on these funds can be as low as 12%-15%. The fund manager invests a major portion of your money in bonds, money markets, CDs and a minor portion in equities. Investors can be sure that no losses will be incurred on these funds. However, this a close-ended fund and you need a least 3 years to stay invested. The returns from Capital Protection Fund are taxable.
Exchange Traded Funds (ETF)
Exchange traded funds belongs to the group of Index Funds and trade like listed shares on the stock exchange. The track an index and invest in an array of assets like equities, commodities, precious metals, currencies etc. Exchange-traded Funds have unleashed various investment options and helps investors to gain exposure to international stock markets and specialized sectors. An ETF functions very similar to stocks. It is a Mutual Fund that can be traded in real-time with price fluctuations at various points in a day.
Funds of Funds
A diversified mutual fund investment portfolio offers a plethora of benefits and a Fund of Funds is one such option that exploits these benefits to the core. The Fund of Funds allows an investor to invest across a variety of funds through a single fund. Hence, instead of buying several funds, investors can just buy a single Fund of Fund and enjoy the benefits of various funds.
Emerging market Funds
Investing in developing markets is a risky proposition and has its own downsides too. India is also one of the most sought after emerging markets wherein many investors bear the brunt of market volatilities. However, if we see things over a long-term, emerging markets have great prospects of contributing to the growth of the global economy. The rate of growth of the economies, the technological advancement, and the skilled labour force are some of the factors which lead to the promising aspects of the emerging economies. Hence, for investors who like to be early movers and take advantage of an untapped prospect, Emerging Market Funds are of a great advantage.
The simplest way to choose the right mutual fund is to identify your goals, risk appetite, and your investment horizon. But whatever you choose, always remember to read the offer document carefully. It is imperative that you weigh your options well before investing.
(1) How are the Mutual Funds classified?
Mutual Funds are classified on the basis of (1) Underlying asset class-Debt, Equity, Hybrid (2) Structure of the Fund-Open ended, close-ended or interval funds (3) Investment Objective-Tax Saving, Capital Protection (4) Special Purpose-ETF, Fund of Funds, Emerging Market Funds.
(2) What are Tax saving options in Mutual Funds?
Equity Linked Savings Schemes or Tax Saving Schemes have a lock-in of 3 years and the investments are eligible for exemption under section 80C. The risk element for these funds is higher, but they also generate higher returns.
(3) How should I choose my Mutual Fund?
You should choose a Mutual Fund based on your investment goals, risk appetite, affordability and time horizon of investment.
(4) How many types of Equity Funds are there?
There are 5 broad classifications of Equity Funds based on Market Capitalisation, Tax saving, Sectors, Diversification and Index.
(5) What are Speciality funds and what are the various types?
Speciality Funds or Special Purpose Funds are funds dedicated to a particular theme or idea. The structure of the fund is designed based on the theme such as Emerging Markets, Pension planning, Capital Protection, Exchange Traded Funds etc.
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