Introduction to Common Types of Mutual Funds
An interesting fact about mutual funds is that they are categorized into numerous divisions based on the nature of the investment, closure of the scheme, under-tax incentive schemes, and spirit of payout. So, a typology within the categorizations points to just how diverse mutual funds can be. So, is a mutual fund in mutual interest? It depends on matching the fund’s direction and the investor’s needs. Let’s explore just how many different types of mutual funds are there. The golden rule of mutual fund investing is that the higher the stakes, the bigger the reward. That said, mutual funds offer many benefits that trading on stocks does not. But along with these benefits come to the risks as well. Read on to know more about the various kinds of mutual funds in the market today.
Common Types of Mutual Funds – Varying Typologies
Each Mutual Fund can declare the type of instrument it will invest in based on the nature of the investments. This divides further into equity fund schemes, diversified funds, gilt funds, money market funds, sector-specific debt fund schemes, and index funds. While debt funds or plans are also called income funds, diversified funds or strategies are called balanced funds.
Based on the scheme’s closure time, the mutual funds can also be categorized into open and closed-ended plans. It is open-ended where there is no specific date when the system will be closed. So, while open-ended funds are more liberal in their outlook, close-ended funds are somewhat narrow-minded!
Based on tax incentive schemes, mutual funds can be divided into tax savings and not tax savings. Another typology is possible based on periodicity/time of payouts, such as dividends. The categorization is as follows:
Dividend Paying Fund Schemes
- Reinvestment Schemes
What is essential is that mutual funds work for the mutual benefit of investors and companies. Schemes can also be in various permutations and combinations. For example, equity funding is open-ended and can have a dividend playing plan.
Look before your leap is a fit adage for the mutual fund markets. Before investment, one should be clear about the scheme’s nature and choose as per risk aversion and periodicity of dividends from the system.
Common Types of Mutual Funds
1. Index funds are those mutual funds that invest in a portfolio of securities representing the entire particular market or its piece. An example would be the whole stock market or just part of it, such as international stocks or small firms. Funds can be built to duplicate the performance of their relevant market. Index funds track the market’s indexes. These funds are affordably priced and easy to maintain. For instance, an NSE index fund will provide the same return as the NSE index.
2. Actively managed funds are actively managed by professionals or portfolio managers who pick stocks that match investment strategies. Concerning the market index, such funds aim to outperform it. For example, active stock managers in India will try to outdo the index rather than track the NSE index. Investors have to pay managers for their work, and it is up to the managers to outsmart the index.
3. Lifecycle or target date funds invest in a blend of stocks and bonds. These are mutual funds that are made of investments in other funds. The allocation of the fund to its assets changes over some time. With age, the investor turns older, and the ratio of money allocated to stocks versus bonds becomes conservative. This works well if you have a portfolio manager monitoring the funds.
Lifestyle funds involve a blend of stock and bond funds that do not change over time. Lifestyle funds can be moderate, aggressive, or conservative.
4. Tax-managed funds are mutual funds that aim to keep taxable capital gains plus other distributions to fund holders to the smallest percentage.
5. Balanced funds are those which invest in a combination of stocks and bonds. These funds typically have a conservative mix of close to 60% in stores and the remaining precutting in bonds. Balanced funds are a combination of growth and income funds. They provide current income and more growth later. Such mutual funds have low to moderate stability. Further striking an even keel, they promise reasonable returns though the investor does experience some risk.
6. Income funds are mutual funds that invest in fixed income securities, generating a regular income. Though this is a durable option, it is not without its risks. Income funds interest rates are sensitive to a certain degree.
Open or Close: The Many Options
A close-ended fund has outstanding fixed shares that operate for a fixed duration of around a decade. Such funds are only open for a limited time and are traded on the stock exchange with a specified redemption period. Open-ended funds are there for subscriptions throughout the year. Unlike close-ended funds, these are not listed on the stock exchange. These are open-end funds because investors have the flexibility to purchase or sell their investment at any point in time.
Opening a World of Possibilities: Different Open-Ended Funds
Debt/income schemes are those where a massive part of the investable fund is channelized via debentures, government securities, and debt instruments. Capital appreciation is low as against equity mutual funds. There is a low risk associated with this type of mutual fund, but there are low returns.
Money market mutual fund schemes are aimed at capital preservation, whereby gains will follow through as interest rates are higher on these types of funds than against bank deposits. These funds pose less risk and are highly liquid. These funds are ideal for investors who want short-term instruments while waiting for better options. Reasonable returns are the USP of these funds.
Equity or growth funds are popular mutual funds among retail investors. This could be a high-risk investment for the short term, but more than make up for it in the long time. For long-term benefits, this is the best open-ended fund.
Index schemes follow passive investment strategies and benchmark indices such as Sensex and Nifty. Another type of open-ended funds is sectoral funds invested in specific sectors such as IT, pharmaceuticals, or capital market segments such as small, medium, and large caps. The risks are high, but so are the returns.
Another type of open-ended scheme is tax saving, which offers long-term opportunities and tax benefits. They are called Equity Linked Savings schemes and have a three-year lock-in period.
Balanced funds are open-ended funds to enjoy growth and income at regular intervals and are perfect for cautious investors yet risk-taking.
Closing the Investment Gap Safely: Close-Ended Mutual Fund Schemes
Close-ended mutual funds have a stipulated maturity period, and investors can only invest during the New Fund Offer period for a limited time. These are protective mutual funds that support and guard capital simultaneously. A close-ended mutual fund is a capital protection. This fund’s principal amount is safeguarded while reasonable returns are delivered. Investing in high-quality fixed income securities with limited exposure to equities is another feature of this mutual fund.
Fixed Maturity Plans or FMPs are mutual fund schemes within a specific maturity period. Schemes include debt instruments that mature in line with a particular period and earn the interest component of securities within a portfolio. The interest component is referred to as coupons. Fixed maturity plans are passively managed, and expenses incurred for this scheme are lower than actively managed schemes.
Interval Mutual Funds: Best of Both Worlds
Operating within the combination of open and close-ended schemes, they give investors the chance to trade units at predetermined intervals.
Managing the Mutual Fund: Active Versus Passive Distinction
Actively managed funds mean active attempts by the portfolio manager to outperform the market or trade benchmarks. Passive management includes holdings where the securities are designed to measure and replicate the performance of benchmark indexes.
One of a Kind: Specialty Funds
These funds are associated with specific mandates such as social causes, commodities, real estate, etc. An example of this kind of mutual fund is social or ethical investing. The fund invests in companies that promote environmental stewardship, human rights, and inclusion while avoiding defense, military, gambling, or alcoholic beverages industries.
Funds of Funds: The Bigger Picture
These funds invest in other funds and are similar to balanced funds. They have higher MER than stand-alone mutual funds.
The Philosophy of Investing: Many Approaches
Portfolio managers follow different investment philosophies and styles of investing to meet a fund’s investment objectives. Funds with varying styles of investment permit diversification beyond the type of investment and are an excellent means of reducing risk.
- Top-Down Approach: This approach towards investing looks at the larger economic picture and invests in specific companies which look set to perform well in the long term.
- Bottom-Up Approach: This focuses on choosing specific companies that perform well regardless of the state of the industry and economy.
- A blend of the two is generally followed by portfolio managers overseeing a global portfolio.
- Technical analysis is yet another style of investing that relies on past market data to detect the direction of investment prices.
Around the World: Mutual Funds by Region
- Global or international funds are those where the investor invests anywhere in the world. The upside of these funds is that they are part of a well-balanced portfolio that reduces risk through diversification while carrying country and political risks.
- Sector funds are targeted at specific sectors of the economy, including health, finance, and biotechnology. This mutual fund scheme is extremely risky and consequently immensely profitable.
- Regional funds focus on certain parts of the world, like a particular region or nation. These stocks make investing easier in foreign countries, but you have to be ready for a high percentage of losses. This is because local factors tend to be very influential in deciding the fate of such mutual funds. From political leadership to economic status, the region’s dynamics affect the mutual fund and the money made from it.
In this article, we have learned about the common types of mutual funds. Many analysts have discussed how mutual funds are subject to risks, and the offer document is an important consideration. Mutual funds have a risk-reward tradeoff whereby the higher the risk, the greater the reward. The only trick is minimizing the risk and maximizing the gains. But the catch is that reward is only possible where there is a risk. Mutual funds are a form of investment that is just as risky as futures trading…the only difference is that you are entrusting the capital to a portfolio manager who is a skilled professional adept at getting the rewards without incurring the risks. Choosing the right mutual fund to invest in can have immediate and long-term financial repercussions. Cash is a fact, but profit is an opinion. Mutual funds make that opinion a certainty.
This is a guide to Common Types of Mutual Funds. Here we discuss the introduction, varying topologies, and the various types of mutual funds. You may also look at the following articles to learn more –