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What are the 3 types of mutual funds?

Mutual funds are popular investment vehicles that offer diversification, professional management, and flexibility to investors. There are over 44 registered mutual fund companies in India, providing a range of options to meet the needs of diverse investors. Broadly, mutual funds can be categorized based on structure, asset class invested in, investment objectives, and risk appetite. Understanding the different types can help align your mutual fund investments to specific financial goals.

1. Structure of Mutual Funds

Based on ease of investment, mutual funds are structured as:

Open-Ended Funds

  • Open-ended mutual funds allow investors to purchase or redeem units any time throughout the year, without any restrictions.
  • Units are bought and sold at the current net asset value (NAV), which gets calculated daily.
  • Open-ended funds are ideal for investors looking for liquidity in their investments.
  • Some examples include equity funds, debt funds, hybrid funds, and solution-oriented funds.

Close-Ended Funds

  • Close-ended mutual funds raise a fixed amount of capital through a New Fund Offer (NFO) during launch.
  • After the NFO, fresh purchase of units is not allowed. Redemptions also happen only at maturity.
  • However, close-ended funds are listed on stock exchanges to allow liquidity through sale and purchase of units.
  • Returns depend on market sentiment and demand-supply dynamics.

Interval Funds

  • Interval funds are a hybrid between open-ended and close-ended mutual funds.
  • They allow purchase and redemption of units at periodic intervals only, unlike daily in open-ended funds.
  • Intervals are predefined, usually monthly, quarterly, or annually.
  • Interval funds provide greater flexibility than close-ended funds.

2. Asset Class of Mutual Funds

Based on where they invest the money collected from investors, mutual funds are categorized as:

Equity Funds

  • Equity funds predominantly invest in shares of companies across market capitalization.
  • Returns are linked to equity market performance. Higher risk but potential for high returns over long term.
  • Types include large cap, mid cap, small cap, sectoral, thematic, ELSS, etc.
  • Suited for investors with high risk tolerance and long investment horizon.

Debt Funds

  • Debt mutual funds invest primarily in fixed income instruments like corporate bonds, government securities, money market instruments etc.
  • Offer stable returns and lower risk compared to equity funds.
  • Categories include low duration, liquid, overnight, gilt, credit risk, dynamic bond funds, etc.
  • Suited for investors looking for regular income and capital preservation.

Hybrid Funds

  • Hybrid funds invest in both equities and debt instruments, usually in a pre-defined proportion.
  • Help balance risk and return expectations.
  • Types include balanced advantage, dynamic asset allocation, and multi asset funds.
  • Suitable for moderate risk-taking investors looking for best of both asset classes.

3. Mutual Funds Based on Investment Objective

Mutual funds can also be selected based on your financial goals:

Growth Funds

  • Growth funds aim for capital appreciation by investing mostly in high growth stocks.
  • Focus on generating long-term capital gains rather than regular income.
  • Ideal for investors with long investment horizon and ability to withstand volatility.

ELSS Funds

  • Equity Linked Savings Scheme (ELSS) funds invest predominantly in equities while providing tax benefit under Section 80C.
  • Have a lock-in period of 3 years, ideal for long-term wealth creation.
  • Help save tax and generate high inflation-adjusted returns simultaneously.

Liquidity Funds

  • Liquid and ultra-short duration funds focus on short-term investments to provide easy liquidity.
  • Invest in money market and short-term debt instruments maturing under 91 days.
  • Meant for parking emergency funds or short-term cash needs.

Retirement Funds

  • Retirement funds invest across asset classes to build a retirement corpus over the long term.
  • Have an extended lock-in period and relatively higher equity exposure.
  • Tailor-made for retirement planning needs.

Children’s Funds

  • Children’s funds build a corpus to meet child’s future financial needs.
  • Have a lock-in of at least 5 years and invest mostly in equities.
  • Ideal for accumulating funds for education, marriage, etc.

4. Risk Profile of Mutual Funds

Investors can also select mutual funds based on personal risk appetite:

Very Low Risk Funds

  • Very low risk funds include liquid and overnight funds that invest in ultra short-term debt and money market instruments.
  • Focus is on capital preservation and high liquidity.
  • Offer slightly higher returns than savings accounts with low volatility.

Low Risk Funds

  • Short duration, corporate bond and banking & PSU funds have low to moderate risk profiles.
  • Meant for stability with some higher accruals than very low risk funds.
  • Ideal for conservative investors closer to goal maturity.

Medium Risk Funds

  • Hybrid mutual funds have medium risk as they balance both equities and debt.
  • Dynamic asset allocation funds can moderate risk dynamically.
  • Offer stability with some equity exposure to fight inflation.

High Risk Funds

  • High risk funds have significant exposure to volatile equities through mid, small, multi-cap funds.
  • Potential for very high returns over long term but with equally high volatility.
  • Suited for investors with high risk appetite and ability to withstand short-term negative returns.

Conclusion

Analyzing the multi-dimensional mutual fund categories can help align investments to financial objectives, time-frame, and risk tolerance. Selecting the right fund also requires studying historical performance, portfolio holdings, expense ratio, and fund manager’s investment style. Investing through Systematic Investment Plans and staying invested for long term can help meet financial goals while averaging out market volatility.

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