3 Types of Mutual Funds And Why it's a Great Investment Tool?

Let’s say you wish to go from Place A to Place B. The most efficient way of going from Place A to Place B is by air. To make this travel, do you fly by a passenger plane or do you book a private jet of your own? For most of us, the answer is the former--we’ll go by a commercial airline.

Now, think of this commercial plane as a mutual fund. Just as the airplane helps you go to Place B, a mutual fund helps you reach a specific investment goal in the most efficient manner. A commercial plane is cheaper than a private jet because you are sharing the flying costs with many others. Similarly, a mutual fund is a cost-effective investment tool because you share the fund management fees with other investors.

What is a mutual fund?

A mutual fund helps you reach your goal or objective by allowing you to benefit from the expertise of a fund manager and his or her team. That too, without burning a hole in your pocket.

In simplest terms, a mutual fund is an investment tool that is used together by a group of investors. Many investors get together and pool their money into a mutual fund. All of this pooled money is managed by an expert fund management team in alignment with the common goal set for the mutual fund.

This is simply how a mutual fund works. Different mutual funds have different fund objectives. Let’s dig deeper into these types.

If you are new to investing then you should also read: What is Mutual Fund and Why You Should Care About It?

Different types of mutual funds

Mutual funds can broadly be categorized into three segments: equity, debt, and hybrid. This categorization is made in terms of the mutual fund’s underlying asset.

1. Equity mutual funds invest primarily in stocks or shares of listed companies
2. Debt mutual funds invest primarily in government papers, corporate bonds or treasury bonds
3. Hybrid funds invest in a mix of these assets mentioned above

Equity mutual funds

The shares of companies listed on Indian stock exchanges like NSE and BSE are called equities. When you buy shares, you get ownership of the company and you participate in the company’s growth. However, investing in shares is risky and requires a large amount of time, knowledge and expertise. It also requires a lot of money. The answer to these problems is equity mutual funds. 

The fund management team does the hard work of choosing the shares for you and since you don’t buy the shares directly, you can invest as little as Rs 500 in an equity mutual fund as well.

Debt mutual funds

An asset class less risky than equities is debt. These are papers and bonds taken out by the government or corporate companies to raise money. When you buy a bond or paper, you don’t get ownership of the company. You just lend money to the bond issuer for a specific period and the issuer promises to pay you back the money along with interest

Debt mutual funds allow you to invest in such government or corporate bonds. Here, once again, you don’t get direct ownership, which is why you are able to buy different kinds of bonds at smaller amounts.

Hybrid mutual funds

Hybrid funds invest in equities as well as debt. Aggressive hybrid funds invest a major part in equities while conservative hybrid funds invest a majorly in debt. 

Hybrid funds allow you to participate in the growth from equities as well as benefit from the stability of bonds. If chosen right, hybrid funds can give you the best of both worlds.

What do I get when I invest in mutual funds?

All mutual funds allot units to their investors. The investors don’t get direct ownership of the underlying assets of the mutual funds. They get units, which are priced accordingly to the assets owned by the mutual fund.

Mutual funds begin with a unit price of Rs 10, which is called the fund’s NAV (Net Asset Value). But remember that a lower NAV does not mean a cheaper fund. The NAV is just the fund’s assets under management (AUM) divided by the number of units created. As the fund gets more investments, it creates more units and hence, the NAV fluctuates. This is why the NAV should not be a determining factor in choosing a fund. 

Are mutual funds safe?

Yes, mutual funds are safe. Mutual funds are regulated by a government body called the Securities and Exchange Board of India (SEBI). This government body ensures that only trustworthy companies are given the license to run mutual funds. Hence, your mutual fund company will not disappear with your money in the middle of the night. In that aspect, mutual funds are safe.

However, your invested money in mutual funds is subject to market and economic risks. No mutual fund guarantees return. The returns are dependent on the investments made by the mutual fund. Hence, the returns could go up and down, even in the negative. From that perspective, mutual funds are riskier than other investments like fixed deposits, but the higher risk also comes with higher return potential. 

Benefits of investing in mutual funds

1. Diversify risks by spreading your investment across asset classes
2. Allow a team of experts to take investment calls on your behalf
3. Begin your investment journey with small amounts
4. Pay only a nominal fee in the form of an annual expense ratio (ER)
5. Choose from a range of mutual funds to meet your investment needs
6. Redeem investments when you need the money

How can you invest in mutual funds?

Mutual fund investments can be made both offline as well as online. The offline route can be taken through a mutual fund distributor or by visiting a fund company’s office. The easier way, of course, is by investing online.

Online investments in mutual funds are safe, secure and straightforward. Get started by creating an account on Wealthy.in.