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Understanding Mutual Funds: Comprehensive Overview of Types

Finance Elite March 19, 2020

Mutual Funds

Everybody wants to grow rich; they want fortune, and a substantial one at that, and, traditionally speaking, hard work is the key to building your wealth over time.

However, what if we told you that you could make your money work for you by choosing the right investment option.

Today, we all know that investments (the properly planned out ones, that is) can play a significant role in the accumulation of wealth. Popular investment options include fixed deposits, gold deposits, mutual funds, and, of late, cryptocurrencies.

However, the volatile nature of cryptocurrencies puts off many people, and the reducing interest rates on fixed deposits have made them less lucrative than ever before. At the same time, market investments are on the rise, reflecting the growing popularity of managed mutual funds.

So, keeping that in mind, here's our take on all things mutual funds.

What are mutual funds?

A mutual fund is a portfolio of stocks or bonds managed by an experienced wealth manager who invests the finances of a large pool of investors in the portfolio on their behalf. The stocks in the portfolio are chosen according to various factors, or variables, such as the risk profile of the assets and projected returns, among other things.

In India, the mutual fund industry's AUM (Assets Under Management) has sky-rocketed from ₹ 11.73 trillion to ₹ 25.49 trillion between June 2015 to June 2020.

This concept is comparable to the different algorithms that define a program to produce optimal results while minimising the risk of crashing.

The algorithms (stocks or bonds) in a program are chosen according to specific variables (risk profile, debt to asset ratio, historical performance), and their execution provides the desired results (ROI).

Besides, just like you may upgrade a piece of software to improve its performance as and when required, your fund manager adjusts the portfolio to ensure it performs well.

Here's a flowchart to understand how MFs work:

How MFs Work


Types of mutual funds:

Just like there are different programs designed to achieve different tasks, there are different types of mutual funds that cater to the requirements of different people. Mainly, MFs can be divided into three types:

1. Equity or Growth Funds

Equity funds invest predominantly in equities or company stocks, with the objective of wealth creation.

These are more susceptible to market risk, which makes equity funds ideal for long-term investors who can benefit from compounding, as well as face reduced risk due to automatic market corrections over time.

The investment policy determines the type of asset either based on company size (Large, Mid or Small Cap), sector (such as Technology), theme (such as Infrastructure), or tax-savings assets.

2. Fixed Income Funds

These funds invest in fixed income securities such as government securities or bonds, treasury bills, and bank certificates of deposits that promise fixed returns over a short period of time.

Of course, these are low-risk instruments. And, as we know, risk is inversely proportional to returns, so these funds might not give very high returns. They do, however, promise assured returns. Therefore, you must include some debt funds in your portfolio to balance out your risk profile.

3. Hybrid Funds

This is a mixed portfolio that invests in both equity and debt assets to reduce the market risk by introducing assured returns on the part of the investment. The risk is lower than on equity funds but more than fixed-income funds.

Compound your wealth not your risks

In the long run, it's not just how much money you make that will determine your future prosperity. It's how much of that money you put to work by saving it and investing it.

Peter Lynch

As you can see, the common variables that impact the success of your investment are mainly your risk appetite and the term of your investment.

Both the factors depend upon your age and stage in life, as well as your investment goals. According to experts, investors who start young stand to gain significantly from compounded returns over time.

However, depending on whether you are building a retirement nest or saving for your child's education, there is a specific MF tailored to your goals.

Therefore, just as you create a proof before finalising a product, it is highly recommended to lay down your financial goals to develop an investment strategy that meets your objectives.

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