Market is going haywire and everyone started saying Mutual Funds Sahi hai and don’t stop your SIP, etc. A mutual fund lets investors pool their money together. They use this pooled fund to invest in a diversified portfolio of stocks, bonds, or other securities. This generation discusses and argues more for better future wealth creation. Many seek stable and reliable avenues for building their financial futures. However, how many of us have gone the extent of knowing about the types of funds, schemes, and available plans? Understanding the different categories, such as equity funds, debt funds, and hybrid funds, is crucial for making informed investment decisions. We should familiarize ourselves with the associated risks, return potential, and investment horizons. This knowledge can empower us. It helps us choose the right fund that aligns with our financial goals. This deeper knowledge not only aids in maximizing returns but also enhances our confidence in managing investments effectively.
Most of us have these questions when we see the ad every time,
- What is Mutual Fund? How MF Works?
- What are the key things as an investor to understand?
- Is Mutual Funds the right option for me?
- What should I know to have the best MF investment portfolio?
- How much should I allocate for Systematic Investment Planning (SIP) every month?
We need to have a clear idea of all the above things. This is necessary even when we have a financial advisor to invest according to our risk & goal. To clearly understand our portfolio and investment, one needs to know the basics. It is essential to learn how our money works to grow into wealth. Let me simplify mutual funds. I will explain them from a common man’s perspective. I’ll also cover key things to know as an investor.
Mutual funds in easy terms are like an individual collecting money from a group of people and using that whole amount to allocate among different places (like stocks, government bonds, real estate, etc.) to make more money over the course of time. The total investment is divided by total number of contributors to get the value of one-unit share. Each group member receives units based on their contribution to the overall investment. When that total asset value increases/decreases accordingly the unit value of the shares allocated to each member increases/decreases proportionally.
The value of each unit is considered as the NAV (Net Asset Value). It is calculated in a financial way by taking the total asset value, subtracting total liabilities (loans that are repayable to banks or other entities), and dividing the result by the number of total units. Each share given to group members based on the amount contributed by them is called a NAV unit. It is just indicative of the number of units held by the investor of a particular scheme. The transaction of the funds is calculated on the terms of NAV units.
In the above-mentioned example, if a firm, a bank, or any other company performs the process, it is called AMC (Asset Management Company). Even in the AMC, an individual person makes the fund allocation. This person is called the Fund Manager. The fund manager creates a portfolio by distributing the collected fund to various asset options. These options include debt, equity, or hybrid schemes. This distribution is guided by research and analysis.
To understand how our money is used in different asset options, we need to understand the major types of mutual funds,
Debt MFs: A debt mutual fund is a type of investment. The fund is allocated to invest in government bonds, Non-Convertible Debentures (NCD), corporate bonds, and other securitized bonds. (Basically, bonds are agreements issued by an entity to borrow loan for a fixed interest) The average returns in debt funds range between 8–10%. The risk is relatively much lower than equity fund.
Debt Funds are further categorised based on duration and bond type:
- Overnight Funds – These are funds invested with a 1-day maturity time. You can redeem your investment in one day or more.
- Liquid Funds – Funds that are invested in money market instruments maturing within 90 days debt securities.
- Ultra-Short Duration Funds – Funds that are invested in debt securities maturing in 3-6 months.
- Low Duration Fund – Funds that are invested in securities maturing within 6-12 months
- Money Market Funds – Funds that are invested in money market instruments with maturity up to 1 year.
- Short Duration Funds – Funds that are invested in securities 1-3 years maturity.
- Medium Duration Funds – Funds that are invested in debt securities with 3-4 years maturity
- Medium-to-Long Duration Funds – Funds that are invested in debt securities with 4-7 years maturity.
- Long-Duration Funds – Funds that are invested in long maturity time over 7 years.
- Corporate Bond Funds- Funds that are invested in corporate bonds i.e., well established public limited companies.
- Banking & PSU Funds – Funds that are invested in debts of banks, Public Service Undertaken companies like BHEL, BEL, BSNL etc.
- Gilt Funds – Funds that are invested in Government bonds of varying maturities.
- Gilt Fund with 10-years Constant Duration – Funds that are invested in Government securities with 10-year maturity.
- Dynamic Funds – Funds that are invested in Debt Funds securities across maturities Credit Risk Funds – invest in corporate bonds of companies with less than highest ratings
Debt funds are applicable as an alternative for all types of bank deposits like Fixed income deposits, recurring deposits etc., Also it is best suited for people with less risk taking capability and who want to choose capital protected investment options.
Equity MFs: An equity mutual fund is a type in which the fund is allocated to invest in shares of different publicly listed companies. The stock prices of companies change due to variations in inflation. Changes in tax rates, currency fluctuations, and bank policies also affect stock prices. Other external economic factors impact them as well. These changes affect the performance of the fund schemes. The average returns in equity funds are much higher than those of debt funds. However, the risk is also equally higher. On average, equity funds give returns of around 12% to 15% annually with moderate to high risk.
Equity Funds are further categorized based on companies’ market capitalization, industries, and scheme strategy where they have minimum of 65% of overall asset allocated into equity:
- Large-Cap – Funds that are invested in top 100 companies with market capitalisation value more than Rs. 20,000 crores.
- Mid-Cap – Funds that are invested in companies with market capitalisation value more than Rs. 5,000 crores and less than Rs. 20,000 crores.
- Small-Cap – Funds that are invested in companies with market capitalisation value less than Rs. 5,000 crores.
- Multi-Cap – Funds that are invested in different capitalisation companies with minimum investment of 25% in each cap.
- Sectoral Funds – Funds that are invested in particular sector of the stock market like Information Technology, Pharmaceutical, Banking, Financial Institutions, FMCG etc.,
- Focussed Equity Fund – Funds that are invested in not more than 30 companies.
Hybrid MFs: It is the combination of equity and debt funds. It is categorised based on the ratio of equity and debt funds.
| Equity MF | Debt MF | Hybrid MF |
|---|---|---|
| Based on Market Capitalization: Large-Cap, Mid-Cap Small-Cap, Multi-Cap | Liquid Funds | Equity Oriented Fund (Where minimum 65% of Asset allocated to equity related schemes) |
| Sectoral Funds | Based on Duration: Overnight Funds Ultra-Short Duration Funds Low Duration Fund Short Duration Funds Medium Duration Funds Medium-to-Long Duration Funds Long-Duration Funds | Debt Oriented Fund (Where minimum 60% of Asset allocated to debt related securities) |
| Focussed Fund | Money Market Funds | Balanced Funds (Where minimum 65% of Asset allocated to equity related securities and balance allocated debt schemes) |
| Corporate Bond Funds. Banking & PSU Funds Gilt Funds Gilt Fund with 10-years Constant Duration Dynamic Funds |
Gold funds are another type of mutual fund. The fund is invested in gold mining companies, physical gold commodities, and other formats of gold. This gives return of around 8% to 10% annually in a long term. Investors should include gold funds in their portfolio. These funds help manage the impact of sudden economic downturns. Examples include Covid19, recessions, or any world war. We have seen all the types of funds that needs to consider for one’s investment purpose and benefit. But there’s one other factor that eat up all the benefit that has been harvested.
Taxability is a major factor to consider while choosing the scheme. This will reduce the benefit when redeeming or breaking the investment before its term ends.
| Equity | Debt | Hybrid | |
| Short Term Gain Tax | Except ELSS – 20% on the gain within 1-year time period. | Gain within 3-year time period is added to your net income and taxed according to the tax bracket. | Based on the fund orientation. |
| Long Term Gain Tax | 12.5% on the gain (if above 1 lakh) more than 1-year time period. | 12.5% on the gain more than 3-year time period. |
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