Mutual funds are one of the most popular choices for investments today. Whether you are new to investing or have years of investing experience behind you, it's important to invest wisely and in funds that serve your goals. Mutual funds come in many sizes and types, adding much diversity to your portfolio.
A first time investor would find the plethora of funds mind boggling and, at times, even a surefooted investor requires guidance to stay focused.
In this short guide, we round up five of the most common categories of mutual funds and everything you need to know about them.
1) Debt funds
Debt funds invest in fixed-income instruments like treasury bills, corporate bonds, government securities, and other money market instruments. There are many categories in debt funds including liquid funds, gilt funds, income funds etc. and their maturity periods range from 1 to 6+ years.
What are the benefits of debt funds?
Debt funds are low on risk thanks to their focus on fixed-income instruments. They offer small but steady returns and you don't get charged TDS. Debt funds are flexible and offer a wide investment horizon from 3 months to over 5 years.
- Risk averse
- Has spare cash to invest
- Wants higher returns than current savings account
- Wants a secondary income
- stream Places importance on liquidity
2) ELSS funds
Equity Linked Savings Scheme (ELSS) funds, also known as tax saver funds, help you save income tax while giving higher returns by investing in stocks. ELSS funds offer the dual advantage of giving tax deductions under Section 80C of the Income Tax Act, and high returns characteristic of equity investments.
What are the benefits of ELSS?
ELSS funds have the lowest lock-in period at three years compared to other tax-saving instruments and have a historically proven record of giving excellent returns. Tax is applicable only on returns of over Rs 1 lakh while deductions are applicable to investments up to 1.5 lakh.
Profile of a typical ELSS funds investor
- Looking at medium to long-term gains
- Wants to make significant purchases like a car, home etc.
- Has an appetite for risk
- Is ok with fluctuations in returns
3) Index funds
Index funds are mutual funds that invest in the stocks within a specific index like the NSE Nifty, BSE Sensex etc. Index funds promise the same returns as the performance of the index, which is dependent on the type of companies listed on it. For example, the BSE Sensex comprises 30 well-established and, usually, high-performing companies like Asian Paints, TCS, HDFC etc.
What are the benefits of Index funds?
The performance of index funds is not dependent on a fund manager, which brings down investment costs. They are far less affected by equity-related volatility, which appeals to a wider section of investors.
Profile of a typical Index funds investor
- Looks at an investment horizon of over 5-7 years
- Is focusing on long-term goals like retirement
- Has a low risk appetite
- Wants stable returns
4) Sectoral funds
Sectoral funds invest in a single sector like IT, pharma, retail etc. and are dependent on the performance of the sector. They can give very high returns and can also act as a key component in your diversification strategy.
What are the benefits of sectoral funds?
Sectoral funds have the potential for high returns. They have the flexibility for portfolio diversification with the ability to allot a certain percentage for each sector.
Profile of a typical Sectoral funds investor
- Is an experienced investor
- Has deep knowledge about the funds' sectors
- Wants to enhance existing portfolio with more diversification
- Has medium to long-term life goals
5) Fund of funds (FOF) - international
Fund of funds (FOF) consists of one fund, which holds a diversified portfolio of multiple overseas mutual funds. FOFs are easy to keep track of because multiple mutual funds are grouped within a single fund.
What are the benefits of FOFs?
One of the biggest benefits is the ability to diversify your portfolio with an exposure to foreign markets. The risks are lower as FOFs are usually managed by highly trained fund managers. FOFs give good long term capital gains and enables you to leverage currency fluctuation to your advantage.
Profile of a typical FOFs investor
- Has limited cash to invest
- Wants maximum returns at minimum risk
- Is focusing on long-term life goals
Mutual funds can bring much gain and help grow your wealth when chosen wisely. They are also easy to understand and manage too. However, mutual funds give you maximum returns and wealth growth only when they are matched well to you. The good news is, there is a mutual fund for everyone. Just pick one.
About the author
Vikas Kothari is the founder of P10 Bank, a digital banking startup designed for young working professionals.