Types of Mutual Funds - A Guide to Choosing the Right Investment Scheme

Two investors may invest the same amount but earn different returns based on the mutual fund they choose. Mutual funds pool money from investors and invest it in securities such as stocks, bonds and money market instruments, managed by professional fund managers.

Since each type of mutual fund follows a different investment strategy and risk level, understanding the various mutual fund schemes is important. This guide explains the types of mutual funds to help investors choose schemes based on their financial goals, investment horizon and risk appetite.

Different Types of Mutual Funds

You will find that mutual funds are categorized on the basis of the goals they serve. Each category has different financial goals, income generation, capital appreciation, and risk appetite.

1. Classification by Asset Class

Considered an asset class, mutual funds are divided into four categories, which are equity, debt, hybrid, and money market mutual funds.

A. Equity Mutual Funds

Equity mutual funds invest in the stocks of companies and aim to generate capital appreciation over the long term. These funds invest across a diversified portfolio of equities, which helps spread the investment across different companies and sectors.

Professional fund managers manage the portfolio based on the fund’s investment objective. Equity mutual funds also offer liquidity, allowing investors to buy or redeem units as needed.

B. Debt Mutual Funds

These mutual funds put your investment in fixed-income securities like bonds, government securities, and other money market instruments. These funds may be suitable for investors seeking relatively stable returns and regular income, depending on the type of debt securities held and the fund's investment strategy.

C. Hybrid Mutual Funds

Hybrid mutual funds invest in a combination of equity and debt securities, offering a balance between growth and stability. By combining both asset classes, these funds aim to provide opportunities for capital appreciation through equity investments while generating relatively stable income from debt investments.

2. Classification Based on Investment Goals

Based on purpose and investment goals, you can choose from 8 different types of mutual funds, including income funds, growth funds, capital protection funds, pension funds, and more.

A. Income Funds

Income funds are a type of debt mutual fund that invests in bonds, certificates of deposit and other fixed-income securities. These funds aim to generate regular income while managing the impact of interest rate fluctuations and credit risk.

B. Growth Funds

This type of fund invests your funds in the equities of companies for the medium to long term and aims at capital appreciation. Instead of distributing regular income, it focuses on reinvesting the profits, helping you in wealth accumulation.

C. Tax-Saving Mutual Funds (ELSS)

Equity-Linked Savings Schemes (ELSS) are a type of equity mutual fund that offers the potential for capital appreciation along with tax benefits. Investments of up to ₹1.5 lakh may qualify for a deduction under Section 80C of the Income Tax Act under the old tax regime.

D. Liquid Mutual Funds

Liquid mutual funds invest in short-term debt and money market instruments, making them suitable for temporarily parking surplus funds. They offer high liquidity and relatively low interest-rate risk, allowing investors to access their money when needed.

E. Capital Protection Funds

These funds are designed to safeguard your principal investment and earn modest returns. Your money is invested in bonds and equities but requires a minimum three-year investment period. The returns you gain will be taxable.

F. Aggressive Growth Funds

These funds invest in high-risk securities with the aim of generating higher returns. These funds can be highly volatile due to market fluctuations and are generally suitable for investors with a higher risk appetite.

G. Pension Funds

Pension funds are designed to help investors build a financial corpus for retirement and manage post-retirement expenses. They aim to provide financial stability during the retirement years.

H. Fixed Maturity Funds

Fixed Maturity Plans (FMPs) are close-ended debt schemes that invest in securities with maturities aligned with the fund's maturity period. They are designed for a fixed investment period and are not normally available for premature redemption from the fund.

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3. Classification by Structure

If we talk about structure-based mutual funds, it includes open-ended, closed-ended, and interval funds that give you flexibility to plan your strategic investment.

A. Open-ended Funds

You can buy or sell their units any time based on the current net asset value (NAV). This structure gives you high liquidity, making it flexible for trading with no restrictions on periods. Investor activity makes the capital fluctuate in these types of funds.

B. Close-ended Funds

Close-ended funds are available for subscription through a New Fund Offer (NFO) for a limited period. These funds have a fixed maturity period, and their units are generally listed on stock exchanges after the NFO closes.

C. Interval Funds

These funds combine features of both open-ended and close-ended schemes. Investors can buy or sell their units at specific intervals set by the fund. Depending on the scheme, the units may also be traded on stock exchanges or made available for purchase or redemption at prices linked to the NAV.

How To Decide the Best Mutual Fund For Yourself

As you have seen, mutual funds differ by purpose, so before deciding on any mutual fund, you must decide on your financial goal first. Similarly, you must analyze the right structure that fits your financial situation.

The following chart will guide you to understand the purpose of what you are actually investing in and decide accordingly:

Apart from choosing among the above funds, you should also decide your time horizon and risk appetite. Moreover, evaluating your fund manager's performance, the fund's past performance, and portfolio composition also becomes necessary.

To lower the risk, you should also consider diversifying your investments across different categories.

Thus, it can be said that there is nothing like “the best mutual fund"; rather, there are multiple factors that make a mutual fund perfect according to your investment needs.

Conclusion

There is a versatile range of mutual funds available for you to invest in. As mutual funds differ by structure, objectives, and asset class, you should consider consulting a financial advisor for a better understanding of the equity, debt, and hybrid nature of funds.

Apart from this, you should also track the record of the fund manager and the fund’s past performance. Undoubtedly, checking all these parameters will help you in taking a decision aligned with your financial goals and building a diversified portfolio to reduce market risks.