Modules for Beginners
All about mutual funds
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Are all mutual funds the same?
In the previous chapter, you saw how there are different types of mutual funds based on the asset classes they invest in. But within each kind of mutual fund category, are all funds the same? To elaborate, are all equity funds similar? And are all debt funds the same? As it turns out, they’re certainly not. Even apart from the differences in asset classes, there are other parameters that help differentiate mutual funds from each other.
In fact, you can have many different types of mutual funds based on their structure, their investment objective, their investment horizon and more. Let’s take a closer look at how mutual funds differ from one another based on some key parameters.
Different types of mutual funds based on their structure
Based on their operational structure, mutual funds can be of two types, namely open-ended and close-ended.
Open-ended mutual funds
Open-ended mutual funds allow you to invest in them at any point in time. Similarly, you can also redeem your investments as and when you need to. These mutual funds have no specific investment tenure or lock-in period.
Close-ended mutual funds
Close-ended mutual funds, on the other hand, come with a definite investment tenure and a maturity period. You can only invest in these funds during the New Fund Offer, and you can typically only redeem your investments after the stipulated lock-in period.
Different types of mutual funds based on their investment objective
You can also classify mutual funds into different categories based on their investment objective. Take a look at the different types of funds categorized according to their investment goals.
The primary goal of these mutual funds is capital appreciation. So, they tend to invest in growth stocks. Any increase in the NAV of the fund units is reinvested back in the scheme, so there is no periodic payout of the returns. However, you can redeem your investments to enjoy the benefits of the capital appreciation.
As the name indicates, these mutual funds focus on giving the investor a source of income they can rely on. So, these funds invest in fixed income investments like certain debt securities. Alternatively, some mutual fund schemes also allow you to choose the dividend payouts option, wherein any gains made by the investments are paid out to you periodically.
Tax-saving funds or Equity Linked Savings Schemes (ELSS) primarily help you save tax. The money you invest in ELSS is eligible for deduction under section 80C of the Income Tax Act up to Rs. 1,50,000. And as their name indicates, ELSS mutual funds invest primarily in equity. They also have a lock-in period of 3 years.
Different types of mutual funds based on their investment horizon
Investors have different time horizons for different goals. And one of the key reasons mutual funds are preferred by all kinds of investors is that they come with many different investment periods, as explained below.
These mutual funds have a maturity period of just one day, making them the most liquid schemes in the market.
Liquid funds typically invest in money market instruments that have a maturity period up to 91 days.
Ultra-short duration funds
For ultra-short duration funds, the Macaulay duration of the assets in the portfolio ranges from 3 months to 6 months. Macaulay duration is simply the period over which the total present value of the future cash flows equals the current market price of the security. In other words, it is the time that an instrument takes to repay itself.
Low duration funds
If you are looking for mutual funds with assets whose Macaulay duration ranges from 6 months to 12 months, low duration funds may be ideal.
Short duration funds
In short duration funds, the Macaulay duration ranges from 1 year to 3 years, making these funds ideal for your short-term goals.
Medium duration funds
Medium duration schemes invest in assets that have a Macaulay duration of around 3 years to 4 years.
Long duration funds
These funds are best for investors with a long-term outlook, since they typically come with an investment horizon of 7 or more years.
Different types of mutual funds based on their management style
Most mutual funds are managed by fund managers, as you have read in the previous chapters. But they’re not all actively managed. In fact, based on their management style, mutual funds can be categorized as follows.
Active mutual funds are managed by dedicated fund managers who decide when to invest, in what assets to invest, when to divest and how much to redeem, based on market cycles and economic developments.
Passive funds, on the other hand, are designed to track market indices. So, the fund manager does not actively choose which assets to invest in. If the composition of an index changes, the fund manager changes the portfolio of the passive fund accordingly. This makes passive funds easier to manage than active funds.
In fact, index funds, which invest in a portfolio that mimics the broad market index, are the most popular kind of passive funds. The key difference in index funds vs. mutual funds is the management style.
As you’ve seen from the discussion above, not all mutual funds are the same. They differ greatly from one another in various aspects, right from the assets they invest in and the way they are managed to their investment horizon, their structure and their investment goal. And now that you’ve seen how different mutual funds are, let’s take a look at another pertinent question in the next chapter - What is a good time to invest in mutual funds?
A quick recap
- Based on their operational structure, mutual funds can be of two types, namely open-ended and close-ended.
- You can also classify mutual funds into different categories based on their investment objective, into schemes like growth funds, income funds and tax-saving funds.
- Mutual funds can also differ from each other in terms of the investment tenure.
- And lastly, based on their management style, mutual funds can be categorized as active or passive funds.
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