Investing in the stock markets might seem complicated to first-time investors. The volatility and the uncertainty associated with stock market might get overwhelming for new investors. This is when mutual funds come to rescue. In this article we will cover different topics such as what is a mutual fund and the working of mutual fund investments. We will also understand different mutual fund categories that can be chosen by you to cater to your financial needs.
What is a mutual fund? How does a mutual fund work?
A mutual fund is a financial vehicle that pools the money of several investors with a common investment objective. This pooled money is further invested in different types of asset classes such as fixed-income securities, equities, cash and cash equivalents, etc. This pooled investment is professionally managed by a mutual fund expert, also known as the fund manager. The fund manager along with his team of researchers and analysts find the best type of investment suited for an investor and invests in mutual funds on their behalf. These fund managers have in-depth knowledge and understanding about the know-hows and working of the stock markets.
When an investor invests in mutual fund, they own a particular amount of mutual fund units that represent a portion of the fund’s holding size. Each mutual fund scheme has a unique investment strategy which is set during New Fund Offer (NFO). Investors can earn profits on mutual fund investments either through capital appreciation (where the returns are re-invested to earn more returns) or through regular dividend or interests. In essence, an investor has an option for either earning regular income through mutual funds through dividend option or earn significant returns on their investments through growth option.
Types of mutual funds
Mutual funds are categorised into different categories based on several parameters. Let’s understand a few common investment parameters:
- Types of mutual funds based on maturity period
Basis the maturity period of a fund, mutual funds are further subdivided into two categories:
- Open-ended mutual funds
- Close-ended mutual funds
- Types of mutual funds based on investment objective
There are three main broad categories of mutual funds based on their investment objective. They are:
- Equity funds – Equity funds are further subcategorized into different types of funds –small-cap equity funds, mid-cap equity funds, large-cap equity funds, multi-cap equity funds, tax-saving mutual funds (ELSS funds), sector funds, large and mid-cap equity funds, mid and small-cap equity funds, index funds, etc.
- Debt funds –Debt funds are further subcategorized into 16 categories. Some of them are gilt funds, credit risk fund, overnight funds, corporate bond fund, liquid fund, short duration funds, ultra-short duration funds, dynamic bond funds, banking and PSU funds, etc.
- Hybrid funds –Balanced funds or hybrid funds are further subcategorized into four types – monthly income plans (MIP), equity-oriented hybrid funds, debt-oriented hybrid funds, and arbitrage funds
As you can see there are different types of mutual funds investment plans available to an investor to cater to their varying needs. Choose a fund whose objectives best align with your investment portfolio and also your investment goals, risk profile, and investment horizon. Happy investing!
Raj Kumar is a qualified business/finance writer expert in investment, debt, credit cards, Passive income, financial updates. He advises in his blog finance clap.