What are the different types of mutual funds ?
Does all mutual funds invest only in equity ?
The common misconception on mutual fund is that they invest only in equities. Mutual funds are categorised as Equities, Balanced and Debt funds. The type of investment in each of the categories vary and hence the risk term associated will also vary across. Different types of mutual funds caters to different set of people. You may be aggressive, moderate or conservative when it comes to taking risk. Invest in each of the category to balance the risk. Know the difference in each one of them. Advantage of investing in equity mutual fund is that they are partially tax free after a year of staying invested in that fund. In debt mutual fund after 3 years you will get the benefit of indexation.
UTI is the first company to launch Mutual funds in India in the year 1964. Slowly it has grown over the years. The longest serving mutual fund is “UTI Mastershare” which was launched in 1986. Compounded return has been at 18% for these many years. Debt funds will have change in returns every year or when ever there is change in interest rates by RBI.
Categories of Mutual fund ;
The need for equity mutual fund has increased as it is safe to have everything as a financial asset. The big advantage is only you know how much you have invested. Your money will be completely safe. Debt funds will get the benefit of indexation. Equity and balanced funds are completely tax free if you stay invested for even a year. No need to worry about inflation in the future.Your money will work for you. You can improve your lifestyle, slowly and steadily.
We can see the broad categories of Mutual funds in India as below,
1) Equity Mutual funds,
2) Balanced mutual funds,
3) Debt Mutual funds
Equity mutual funds invest only in Equities or stock market. This in turn has several other types like Large cap, Small & mid cap, Sectoral, closed ended funds etc. More than 90% of the holdings consists of equities. Each fund have been started with a theme and fund will not deviate from it, for example “SBI Bluechip fund” is a large cap oriented fund. Its holdings mainly consist of large cap stocks.
Large cap, Mid cap or small cap –
A company listed in Indian share market will have market capitalisation. Based on it, they are identified as Large cap, mid cap or small cap stocks. For example, TCS, Reliance is called large cap as it has bigger market capitalisation.
Returns can be compared with respective index. For example large cap companies will be compared with Sensex in that particular period.Small & mid cap index will be compared with Small & mid cap index. Sectoral index will be compared with respective sectoral index like IT, Pharma, FMCG, Banking etc.
Generally returns of Small & mid cap funds will be higher during a particular period. It will be during market rally. It will match with economic upturn or there is change in Government at the centre. You need to understand the difference between investing in each of the funds. Reason being equities need investment discipline. Else it may even give you negative returns.
Risk associated with equity funds are high. You can choose this fund type if you can stay invested for a period of more than 3-4 years or planning for your long term goals. It is good to check the Alpha and Beta of the mutual funds before you are investing if you are investing on your own. Else you can depend on your financial advisor to know more. Expense ratio may be higher in these type of funds as they churn more for better returns. SEBI has capped the expense ratio at 2.5%.
Balanced Mutual fund will have 65% of its investment in equities or stock market and remaining 35% in Bonds or debt funds. 65% equity concept should be clear as we have seen them in the previous category. Debt funds are nothing but the funds which provide returns better than prevailing interest rates. Depending upon the situation the debt constituent varies but not exceeding 35%. The advantage of this fund is that during market lows they buy equities which are available at cheaper price and keep holding till they reach its high. Hence the advantage is higher in the category for those who want to get benefit of equity along with debt.
Returns can be on par and better than large cap equity funds at times as during market rally it will perform better. In the recent years, many new entrants came into mutual funds and most of them had invested in this balanced fund as this has inherent power of equity. Some of the funds are in market for a period of more than 15 years like Tata Balanced fund. It has given more than 15% compounded returns in this period.
Risk associated with Balanced fund is less compared to equity. The inherent risk of equity fund stays in this also as sometimes they buy more small or mid cap chasing returns. Expense ratio of balanced funds will be lesser as part of it is invested in debt funds.
Debt funds provide safer returns compared to equity and Balanced funds, hence the returns of debt funds cannot be compared with equity or balanced funds and it can provide higher returns during interest falling period. One simple logic which can be applied is when RBI interest rate is being reduced, Debt funds will perform better or higher returns will be generated and when RBI interest rate is raised DEBT fund returns will fall. This can be used for starting the saving some amount out of salary or recommended for conservative investor, can be utilised for person investing for a period of 2-3 years or more.
How to use debt funds ?
Similar to equities, here also there are different types of debt funds available like Liquid funds, Short term debt funds, Long term debt funds, Credit opportunities funds etc. During falling interest rate this can even give more than 12% also.
If you want to park your money for a week’s time or month’s time you have liquid funds. If you have more than 2 months to one year time frame you have ultra short term funds. In these two types there is no entry and exit loads. If you have more than 12 months to 18 months you have short term debt funds were there is exit loads. If you have more than this timeframe you can invest in long term debt funds for a period of upto 3 years.
Risk associated with debt funds though is called safer, but the returns are not guaranteed as interest rates at times may be negative. Invest based on the time period and choose as mentioned to have better planning. So be careful while choosing debt funds and consult your Financial advisor.
Why you need mutual funds;
- Highly regulated
- Suitable for all types from Aggressive, Moderate and conservative
- Suitable for short, mid and long term investing
- You can make Goal based investing
- Fund manager takes care of investment portfolio
- Easy to invest and monitor
- Less risk in equity mutual fund investments compared to direct equity buying
- Wide measures taken to control mis selling of products.
- You can approach Independent Financial Advisor (IFA) and enquire everything before investing in particular fund
- SIP or Systematic Investment Planning can bring in habit of savings along with Investment benefits.
- Grow your financial asset in hassle free way
Your Reasons to avoid;
If you still have inhibitions on investing in mutual funds, list down the points which may stop you. Think of clearing those doubts rather than avoiding this altogether. This product can easily inflate your lifestyle if you have disciplined investing. Let me try to list down the points which stop you,
There is ULIP –
Yes, with change in rules listed by SEBI it is a better product now compared to that existed before 2010. Do you know the charges are anywhere between 6 to 8%? Do you know that although switches are allowed you need to put all your investments into any one type of investment. For example, you need to invest in mid cap or full equity to get double digit returns. Else the returns will be lower which will not be told by some of the bank employees.
Your friend had lost money –
It doesn’t mean that you will also lose. You and your friend’s thoughts or risk taking ability may be different. Your friend would have invested based on some one else advise which may be improper. Your friend would have invested and taken during bear market, Your friend didn’t understand and invested in equity for a short term of 1 year, which is wrong. Get all these doubts cleared with a financial advisor.
It’s complex –
Investing in mutual funds is not complex and they follow the same process of recurring deposit. You can try debt mutual funds and then try investing in equity for your long term goals
Demat Account –
No demat is needed. Demat facilitate to have the units of mutual funds in electronic mode. It eases the process of purchase and redemption.
You can see in detail about each of these categories in next few articles. The main objective is that, mutual funds can be used as investment tool for all age groups depending upon the risk category. Everything has been discussed in detail here for your easy understanding. If you still have anything to be cleared off, post your comments here.