Building wealth is a gradual process, but with the right investment avenue, such as mutual funds, your wealth creation journey can become easier and more systematic. Mutual funds are an effective way to achieve your financial goals, and many Indians in the last few years have opened their eyes to the benefits of this wealth-creation vehicle. The fact that the Indian mutual fund industry has experienced a rise of 527% in the overall Assets Under Management (AUM) in the last ten years – as of June 2024 – is enough proof of this.
However, if you are new to mutual funds or are looking to expand your portfolio, the wide variety of schemes can get a bit confusing. Choosing the right mutual fund is crucial if you want to achieve your financial goals at the right time. With that in mind, here’s a guide on decoding mutual fund types and how to choose the right option for your needs and preferences.
Decoding Types of Mutual Funds: Categories and Sub-Categories
First, a small primer on what a mutual fund is: it is an investment scheme where an asset management company (AMC) pools funds from various investors. These funds are invested in stocks, bonds, debentures, and other securities as per the type of mutual fund. The contribution of each investor determines the number of units they are given, as per the prevailing Net Asset Value (NAV). The investor can redeem the allocated units when they want to access money from the mutual fund scheme.
AMCs categorise mutual fund investments based on the types of assets they invest in and their objectives. Below is a breakdown of the main categories:
1. Equity Mutual Funds
Equity funds invest mainly in stocks and other equity-related instruments. They aim to provide long-term capital growth and are suitable for investors with a higher risk appetite and a longer investment horizon. Following are some popular equity mutual fund types:
a. Large-Cap Funds
These funds invest in established companies ranked in the top 100 in India by market capitalisation. They offer stable returns and are less risky than other equity funds.
b. Mid-Cap Funds
These invest in medium-sized companies ranking between 101 and 250 by market capitalization. While riskier than large-cap funds, mid-cap funds also have a higher potential for growth.
c. Small-Cap Funds
Focused on smaller companies ranked 251 and beyond, these funds come with high risk but offer significant growth potential.
d. ELSS Funds (Equity Linked Savings Scheme)
If you want to enjoy Section 80C tax benefits, ELSS funds are the right option. With a three-year lock-in period, they invest heavily in equities and are a good option for tax-saving while growing wealth.
2. Debt Funds
Debt funds invest in fixed-income instruments like bonds, government securities, and money market instruments, which offer stable and low-risk returns. Debt mutual funds are mostly preferred by conservative investors. Debt funds have sub-categories as well, like:
a. Liquid Mutual Funds
These funds invest in short-term debt instruments with a maturity of up to 91 days. As their name suggests, these funds offer high liquidity.
b. Overnight Mutual Funds
These funds are focused on securities with a 24-hour maturity, also called tri-party-repo or TREPS. Due to their extremely short window, they have minimal risk and are ideal for parking surplus funds temporarily.
c. Money Market Funds
These invest in short-term money market instruments such as treasury bills and commercial papers with a maturity period of up to 1 year, while still ensuring high liquidity.
d. Gilt Funds
Considered one of the safest debt mutual fund investments, gilt funds invest primarily in government securities.
3. Hybrid Funds
Hybrid funds are a mix of equity and debt investments and cater to moderate-risk investors.
a) Aggressive hybrid funds allocate more to equities for growth.
b) Conservative hybrid funds lean more towards debt for stability.
c) Balanced hybrid funds invest in equity and debt in a defined ratio.
4. Solution-Oriented Funds
These funds are designed for specific goals, like saving for retirement or a child’s education. They usually have a lock-in period to help you stay committed to your investment plan.
5. Index Mutual Funds
Index funds follow a specific index, such as Nifty or Sensex, by investing in the same stocks as those in the index. Since these mutual fund investments do not require active management, they have lower fees and are a good choice for long-term investors looking for affordable options.
Now that you know the various types, let’s explore how to choose a mutual fund that is right for you.
Which Mutual Fund is Right for You?
Here’s a guide on how to pick a mutual fund that aligns with your needs:
1. Define Your Financial Goals
Are you saving for retirement, to buy a home, or to access funds during an emergency? Different goals call for different fund types.
2. Consider Your Risk Tolerance
Equity funds suit those comfortable with higher risks, while debt funds are better for conservative investors. Hybrid funds provide a balance between the two.
3. Consider Your Investment Horizon
Debt or liquid funds are ideal for short-term goals (1–3 years) while equity funds serve long-term goals well (5+ years). Keep the lock-in period in mind when choosing a fund.
4. Diversify Your Portfolio
To ensure steady access to funds for all life events, it is best to spread your mutual fund investments across multiple fund types.
5. Look at Costs and Performance
Other parameters being necessary, there is no skipping over a fund’s expense ratio and past performance. Lower expenses and consistent returns over time indicate a reliable fund, even though past performance cannot be directly indicative of future returns.
The above factors can help you better understand how to choose mutual funds that fit your financial strategy.
Before you get started, you must first choose the right mutual fund distributor who offers a variety of scheme options. IndusInd Bank offers a wide range of mutual fund options tailored to your needs. They have risk profiling assessments to help you personalise your investment plan, as well as goal-based investment options. What’s more, you can begin your investment journey with just one click. So, why wait? Start investing now!
Conclusion
Mutual funds are a solid tool for wealth creation; they offer options for every type of individual. As an investor, you must get a clear idea of your risk profile, goals, investment horizon, and budget to choose the right mutual fund. With the right platform at your side, you can take gradually bigger steps towards your financial dreams and turn them into reality at the right time.
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