Q: There are so many types of mutual funds. Often, I get confused. What are these types of mutual funds?

What’s with these types of mutual funds? Why are there so many types of mutual funds?

Mutual funds are classified based on different aspects. Different types of mutual funds can fetch different returns. The Direct funds vs. Regular funds are classified further based on the asset type in which they invest your money (for example bonds, stocks, gold, etc). This classification is closely related to the investing strategies followed by the fund. We will see what are the basic types of mutual funds below.

Equity MF – Market Cap based

A mutual fund categorized by market capitalization (i.e., small-cap, mid-cap, or large-cap) indicates the size of the companies in which the fund invests, not the size of the mutual fund. Market capitalization is calculated by the number of shares outstanding, multiplied by the current market price of one share.

  • Large-Cap: The large-cap funds invest most of their corpus in the largest companies in terms of market capitalization. These schemes generally carry lower risk and should offer modest returns.
  • Mid-Cap: These schemes predominantly invest in mid-sized companies. These schemes are risky and volatile. They are meant for aggressive investors. The investment horizon needs to be 7-15 yrs.
  • Small-Cap: These schemes invest mostly in smaller companies. Small companies can be extremely risky, but also have the potential to offer higher returns. The investment horizon needs to be 10-20 yrs.
  • Multi-Cap: The schemes try to equally invest in all the above mentioned large, mid, and small-cap companies. The fund houses typically offer different combinations here like Large-Mid, Mid-Small, etc.

Equity MF – Dividend Yield Fund

This is a new category introduced by Sebi in the re-categorization exercise in 2017. The schemes under this category invest in dividend-yielding stocks or stocks that pay periodic dividends.

Equity MF – Value Fund

The schemes in this category follow the value style of investment. The value investment style is where the fund manager bets on stocks that are undervalued. A word of caution, not everyone can pick undervalued stocks.

Equity MF – Contrarian Fund

These schemes follow the contrarian investment strategy. In the contra style of investing, the fund manager takes a contrarian view (Does not follow the herd).

Equity MF – Focussed Fund

These schemes invest in a maximum of let’s say 30 stocks. The scheme would mention which market cap it tends to focus on. They can be extremely risky if the fund manager’s call of stock picking goes wrong. However, they can offer great returns if the stocks perform.

Equity MF – Sectoral/Thematic Fund

These schemes invest in a particular theme or sector. Sectoral or thematic funds are generally considered risky for retail investors because their fortunes depend on the performance and cyclical nature of a particular sector.

Equity MF – ELSS (Equity Linked Saving Scheme) Fund

ELSS are tax-saving mutual fund schemes with a lock-in period of three years. They are pure equity funds.

Money Market or Gilt MF

These funds invest in short-term fixed-income securities such as government bonds. They are generally a safer investment, but with a lower potential return then other types of mutual funds.

Debt Funds

These funds buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds, and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through the interest that the fund earns. High-yield corporate bond funds are generally riskier than the funds that hold government and investment-grade bonds.

Balanced Funds

These funds invest in a mix of equities and fixed-income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split the money among the different types of investments. They tend to have more risk than fixed-income funds, but less risk than pure equity funds. Aggressive funds hold more equities and fewer bonds, while conservative funds hold fewer equities relative to bonds.

Index Funds

Alas! We come to very cost-effective funds. I call it cost-effective for a reason. These funds aim to track the performance of a specific index such as the Nifty50 Index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.

There are a lot of different other types of mutual funds in the market that fund houses offer. I have tried to mention major types that most investors usually prefer. I advise you to gain more knowledge before you make informed decisions about investing or approach a financial advisor who can suggest a mutual fund based on the risks that you can take.

Happy investing!

Disclaimer: All of the information I share here is strictly to educate my blog readers. Please do not consider any advice as a recommendation. Read the disclaimer.