Understand Types of Mutual Funds and How Mutual Funds Work

The first mutual fund in India was established in 1963 with the establishment of Unit Trust of India, a joint venture of the Indian government and the Reserve Bank of India (RBI). Since then, the industry has evolved gradually, with private firms joining the market in 1993. Today, in India, 44 Asset Management Companies (AMCs) provide over 2,500 mutual fund plans to meet different investors’ aims and risk appetites.

Mutual funds, formerly a minor player in the financial market, today play a significant and crucial role in pricing tradable assets such as stocks and bonds.

So, if you’re considering investing in mutual funds because it is trendy or you’ve probably watched the ‘Mutual Funds Sahi Hai’ ad too many times to start believing it, probably wait a minute. Because we don’t want you to cry over spilt milk or lost money in this case. We’ll walk you through the types of mutual funds in India, different types of mutual funds, types of mutual fund schemes, and more. So, straight to the point, let’s get into the core of ‘seasoned players ka all-season investment’ – mutual funds. 

Key Takeaways

• Mutual funds are professionally managed investment programmes
• Equity Funds, Debt Funds and Hybrid Funds are the three primary different types of mutual funds in India.
• Annual fees [known as Expense Ratio or Total Expense Ratio (TER)] and, in some cases, commissions are charged by mutual funds, which can affect their overall results.

Decoding How Mutual Funds Work

When it comes to investments, the most prevalent advice is that if you start investing in mutual funds, you will become wealthy! However, for some reason, no one seems to have a definitive solution to the age-old question of how mutual funds work. But today, you are in luck, because we’ll talk about it.

Mutual funds aggregate money from a group of investors to invest in various assets, including stocks, bonds, and government securities. Each mutual fund scheme has a strategy at the time of the NFO (New Fund Offer). Once a plan has been established, the fund must keep to it. Mutual fund investing is a four-step process that begins with the launch of an NFO and ends with the distribution of returns.

A mutual fund is simply a virtual corporation that receives money from multiple investors and invests it in various stocks, bonds, and other investment instruments on their behalf. The fund is managed by a professional portfolio manager who buys and sells securities to ensure the fund’s effective growth. When a person participates in mutual funds, the money invested in various securities is divided into units and distributed to the investor. The investor’s portfolio is made up of various investments in various instruments. As a result, when someone invests in a mutual fund, they effectively become shareholders in the company. When the units perform well, the mutual fund’s investors earn a portion of the profits in dividends.

The overall cost of a mutual fund is determined by the price of each fund unit, also known as the fund’s Net Asset Value (NAV). The price at which investors buy or sell their units is referred to as this value. The NAV of a fund and the market price of a unit or share, on the other hand, are considerably different. In a mutual fund, the concept of a market price for a share does not exist. A mutual fund’s NAV is computed at the end of each market day. The total value of all investments in a fund’s portfolio, less liabilities, is divided by the number of outstanding units to arrive at the NAV.

Understanding Different Types of Mutual Funds in India

Today, investors are becoming more inclined towards the different types of mutual funds in India. This is because mutual funds investment options offer a variety of advantages to investors. A diverse portfolio, competent portfolio management, flexibility in investments through SIPs, and a lump amount are just a few advantages.

The Securities and Exchange Board of India (SEBI) regulates the mutual fund business in India. Although SEBI has classed mutual funds based on where they invest, mutual funds can also be classified in various ways. So, here’s an overview of the different types of mutual funds in India.

Equity Funds

An equity fund is a mutual fund that invests largely in company shares or equities. They’re also known as growth funds.

Active and passive equity funds are the two types of equity funds. A fund manager in an Active Fund searches the market, does company research, analyses performance, and looks for the best stocks to invest in. The fund manager of a Passive Fund creates a portfolio that closely resembles a famous market index, such as the Sensex or the Nifty 50.

Furthermore, Market Capitalization, or how much the capital market values an entire company’s stock, can be used to divide Equity Funds. The different types of mutual funds in India can be categorized as Large Cap, Mid Cap, Small Cap, or Micro-Cap.

Diversified or Sectoral / Thematic classifications are also possible. The former invests in companies across the entire market spectrum, whereas the latter is limited to certain industries, such as information technology or infrastructure.

Debt Funds

A debt fund is a Mutual Fund scheme that invests in fixed income products such as corporate and government bonds, corporate debt securities, and money market instruments that provide capital appreciation. Debt funds are sometimes known as fixed income funds or bond funds.

Low-cost structure, reasonably constant returns, great liquidity, and decent safety are just a few of the primary benefits of investing in debt funds.

Debt funds are great for investors who want a steady income stream but don’t want to take any risks. Debt funds are less risky than equities funds since they are less volatile. They help you achieve your financial goals more tax-efficiently and earn greater returns.

In terms of functioning, debt funds are comparable to other Mutual Fund schemes. They do, however, outperform equity mutual funds in terms of capital safety.

Hybrid Funds

Hybrid funds, formerly known as Balanced Funds, invest in two or more asset categories to provide the investor with the best of both worlds. In the Indian mutual fund sector, there are several types of hybrid funds. Some funds invest in both equities and debt and debt and gold. On the other hand, most popular hybrid plans invest in both equity and debt assets. Different types of hybrid funds use different asset allocation methodologies. 

So, before you invest, make sure you know what you want to achieve.

Did You Know?

In May 2021, the mutual fund sector reached a milestone of 10 crore folios!

As of March 31, 2022, there were 12.95 crores (129.5 million) accounts (or folios in mutual fund lingo), with roughly 10.34 crore folios under Equity, Hybrid, and Solution Oriented Schemes, where the greatest investment came from the retail segment (103.4 million).

The Investing Attitude: Helping you with the Advantages and Disadvantages for Better Decisions

Putting together a mutual fund portfolio is akin to putting together a house: Although there are numerous tactics, designs, tools, and building materials available, each structure has some common characteristics.

To put together the finest mutual fund portfolio, go beyond the wise advice of “don’t put all your eggs in one basket”. A sturdy foundation, a smart design, and a straightforward combination of mutual funds that perform well for your needs are all required for long-lasting construction.

And what better way to stay on top of your game than knowing about the pros and cons of the different types of mutual funds in India? So, here we are, sharing the advantages and disadvantages of the different types of mutual funds in India to help you become a smart investor.

Word to Remember

Net Asset Value

The market value of all securities held by the mutual fund scheme is the Net Asset Value (NAV). The NAV measures the performance of a mutual fund scheme.

The NAV per unit of a mutual fund can be calculated by dividing the market value of the mutual fund scheme’s securities by the total number of units in the mutual fund scheme on any given date.

NAV = (Assets – Liabilities) / Total number of outstanding units

Conclusion

American writer and Pulitzer Prize winner Ron Chernow aptly said, ‘Mutual funds give people the sense that they’re investing with the big boys and are really not at a disadvantage in entering the stock market.’

So, what’s stopping you from entering the big leagues now that you know about the different types of mutual funds in India and the types of mutual funds schemes.

But our last words before you get onto your phone or computer screens to start with the different types of mutual funds in India.

Choose from the different types of mutual funds in India that best suit your investment preferences and risk tolerance. When choosing the right mutual fund plan, consider your financial goals and time horizon. Build a diversified portfolio using various types of mutual fund schemes to spread your risks and maximize your portfolio’s return-generating potential.

FAQs

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