What are mutual funds? Its types and subtypes explained

Mutual funds are an excellent investment channel that can help you create wealth in the long term. A mutual fund utilises the capital collected from a pool of investors to buy stocks, bonds or shares of a company. Mutual fund investments are managed by professional managers whose primary aim is to produce income or capital gains by allocating the fund’s assets.

Typically, there are three types of mutual funds. These include equity funds, debt funds and hybrid funds. The article looks at each category and its main subtypes to help you make an informed decision as you invest in mutual funds.

• Equity funds

Equity funds invest primarily in company stocks and are regarded as stock funds. They are one of the most popular mutual fund schemes that offer a high return potential in the long run but also carry a high risk commensurate with the returns.

The popular sub-types include:

• ELSS

Equity Linked Savings Scheme or ELSS is a tax-saving investment option that offers a tax deduction under Section 80C up to Rs.1.5 lakh.

• Large-cap funds

Large-cap funds invest a minimum of 80% of its assets in blue-chip companies that are considered reputable and trustworthy. These funds are best suited for investors with a low-risk appetite.

• Debt funds

Debt funds invest in fixed-income instruments such as certificates of deposits, corporate bonds, and government securities, among others. They are ideal for investors looking for a regular or steady income and a low-risk-low-return outlook.

The main subtypes include:

• Money-market funds

Money market funds invest in money market securities such as treasury bills, bonds, dated securities, and more. You can earn regular dividends on these funds, and they can be relatively less risky.

• Gilt funds

Gilt funds mainly invest in government securities for a long term and can be virtually risk-free i.e. absence of credit risk. However, these funds may be subject to high interest rate risk.

• Hybrid funds

Hybrid funds invest in a mix of equity and debt funds. In some cases, the proportion of equity funds is higher, while in others, debt funds may have more weight. The ideal combination can be tailored to meet the specific needs of the investor.

The top sub-types include:

• Equity-oriented hybrid funds

These funds invest 65% or more of the fund’s assets in equity mutual funds and the remaining 35% in debt funds and money-market instruments.

• Debt-oriented hybrid funds

These funds invest 60% or more of the fund’s assets in debt instruments and the rest in equity funds. For liquidity, some portion of the fund may also be invested in cash and cash equivalents.

Conclusion

With multiple options to choose from, picking the right mutual fund can be difficult sometimes. To help make the right choice, consider factors such as your investment objective, risk appetite and investment horizon. This can help you enjoy the enhanced benefits of mutual funds by selecting the right mutual fund type to achieve your financial goals.

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