Ajay, a 32-year-old software engineer in Hyderabad, welcomed his baby daughter recently. He wanted to start investing to secure his daughter’s future, and his top priority was buying a bigger house. When he learned about mutual fund returns, he wanted to invest in it. However, he was overwhelmed by the different categories of mutual funds.
If you are also like Ajay, waiting for a simple explanation of the difference between direct and growth funds and more, this blog is right for you!
Read on to learn about the different mutual fund options.
Mutual Fund Investments – Overview
A mutual fund is an investment vehicle where a fund manager puts together an investment pool consisting of stocks, bonds, and other securities. Investors who invest in mutual funds own units of these aggregated assets and generate returns based on the performance of the mutual funds. The fund house offers different types of mutual fund schemes, and the fund managers make decisions for every mutual fund they control. Investors who invest in mutual funds don’t have any control over the diversified pool of assets included in the mutual funds. Still, their returns are determined by the performance of all the underlying assets.
You must first understand the difference between stocks and mutual funds. When you buy a company’s stock, you become a partial owner and benefit from the company through dividends and capital appreciation. With mutual funds, you do not get direct ownership of the underlying company stocks. You will only own units of mutual funds, even though the funds invest in varied equity stocks.
Even though shares are used interchangeably with units from a mutual funds perspective, shares represent direct ownership of the company. Mutual fund shares refer to the units of mutual funds, a collective investment scheme.
Mutual Funds Based on the Underlying Portfolio
Your returns from mutual fund investments depend on the asset classes in which investors’ funds are invested. In the case of equity funds, most of the investment is invested in stocks. The fund manager chooses shares and stocks of companies from diversified sectors to invest in. The returns from equity mutual funds depend on the performance of the underlying company stocks.
When mutual funds invest primarily in fixed-income securities like bonds, treasury bills, etc., they are called debt funds. The major difference between equity and debt funds is the risk and reward. Equity funds are highly riskier than debt funds. However, equity funds offer better returns than debt funds, mainly due to the capital appreciation potential.
You can choose hybrid funds if you want a mixture of debt and equity funds for optimal returns. Asset allocation is split between debt and equity assets. Again, the risk and reward varies based on the asset allocation.
Mutual Funds Based on Organisational Structure
Open-ended mutual funds allow you to invest and redeem your investment anytime. There is no specific maturity tenure or investment timeline. Open-ended mutual funds are highly liquid, allowing you to invest or redeem based on the Net Asset Value (NAV).
Closed-ended mutual funds, on the other hand, have a lock-in period, as there is a fixed maturity tenure. You can invest in these types of funds only during the New Fund Offer (NFO) launch. For redemption, you must wait until the maturity period ends. Since your investment is locked in these funds, closed-ended funds are not very liquid.
However, SEBI has mandated fund companies to provide an option for investors to exit. So, you can sell your mutual fund units back to the company or list them on the stock exchange to redeem your funds before the maturity period.
Interval mutual funds allow you to invest and redeem at specific time intervals. These are a special type of close-ended funds, where you can enter or exit the fund within the window.
Mutual Funds Based on Channels
You can invest in direct mutual funds directly through the Asset Management Companies (AMCs) without any distributor or broker. With the online investment option, you can choose any AMC and invest in their mutual fund schemes without an intermediary. You can get all the returns from the mutual funds, but you must review your investments periodically and switch investments based on their performance.
On the other hand, regular mutual fund investments allow you to invest your money through a broker or distributor who can invest in different types of funds on your behalf. You can trust your distributor to manage your investment, but your returns will be lower because you must pay the broker for their service.
Mutual Funds Based on Investment Goals
Growth funds allocate significant assets to shares and growth sectors. You can choose riskier growth funds to meet a long-term financial goal if you have surplus cash. Growth funds usually offer higher returns. Generally, the returns are reinvested with growth funds, allowing compounding returns.
On the other hand, dividend funds pay out dividends regularly that you can redeem. This provides a steady income stream, and dividend payouts are based on the type of funds you invest in.
Mutual Funds Based on Investments
When you receive a large bonus or have surplus cash, you can invest the lumpsum amount in any mutual fund you choose. If you are willing to save periodically and invest that in mutual funds, you can do so with a Systematic Investment Plan (SIP). AMCs generally provide lumpsum and SIP options for all types of mutual funds. Instead of letting your savings sit in your savings account, you can choose SIP and invest weekly, monthly, or quarterly in mutual funds. You can invest a lumpsum amount to maximise returns and then continue investing using SIPs.
Conclusion
As mutual funds continue to gain popularity in India, many more types of mutual fund schemes are also available. For example, you can invest in exchange-traded funds (ETFs), where investments are made in assets specific to a sector or a fixed number of sectors. Thematic funds allow you to invest based on investment goals like tax savings, child welfare, retirement, etc. Each mutual fund option has a different risk profile and asset allocation. Before investing, choose the suitable scheme for your investment goals and risk appetite.
FAQs
When you invest in stocks, you will gain partial ownership of the company, but your returns are tied to the performance of the company stocks in which you invest. With mutual funds, no ownership follows, but you can dilute risks with built-in diversification.
You can invest in mutual funds as a lump sum if you have surplus money you won’t need immediately. However, if you wish to build your wealth slowly and steadily, consider SIPs.
Equity funds invest primarily in stocks and offer higher returns at a higher risk. Debt funds invest primarily in fixed-income securities and provide regular interest payments. Debt funds have lower risk and lower return potential.
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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.