Mutual funds (MFs) may suit the financial needs of any person – be a risk taker or a risk averse. There are also different categories of funds to cater to the short-term or long-term needs.
As the tax-saving investment session is in full swing, equity-linked savings schemes (ELSS) are in the limelight. However, many interested investors drag their feet after seeing the statutory warning – “Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.”
However, mutual funds (MFs) are not all about tax savings and market risks, and may suit the financial needs of any person – be a risk taker or a risk averse. There are also different categories of funds to cater to the short-term or long-term needs.
Mutual funds may be broadly divided into two categories – equity MFs and debt MFs. There is another sub-category, called hybrid funds, which may fall under either equity or debt, depending on how much investments the fund may have in equity and debt.
Equity Mutual Funds
An equity MF invests at least 65 per cent of its funds into equity and equity-related instruments, which may go up to 100 per cent depending on market opportunities. The remaining 0 to 35 per cent of the fund may be invested in debt instruments to manage risks depending on market volatility.
Equity MFs may further divided into large-cap funds, mid-cap funds and small-cap funds, depending on the category of companies in the shares of which investments are made. Risks increases when investments are made in mid- and small-cap companies, but enhances the chance of higher returns.
While market fluctuations affect equity MFs directly in the short term, the effect of market risks gradually reduces and results into gains superior than other investments in the long term. So, money needed in less than three years should not be invested in equity MFs and one should enter into equity investments only with the goal of generating long-term wealth.
So, the horizon of investments in equity MF should be more than 3 years.
ELSS funds also fall under the equity MF category, which gives benefits u/s 80C of the Income Tax Act. Such funds have a lock-in period of three years.
Debt Mutual Funds
The portfolio of debt MFs consists of at least 65 of debt instruments, like government securities, treasury bills, money market instruments, rated company deposits etc. As such instruments have a fixed tenure and pre-determined maturity value, the return on such funds may be predicted and may be used for regular returns. Such funds are not as volatile as equity funds and may provide better return than fixed deposits (FDs) as debt MFs are tax and inflation efficient investments.
Depending on the nature of instruments, in which investments are made, debt MFs may further be divided into liquid funds, gilt funds, accrual funds etc.
The horizon of investments in debt MFs may vary from less than 1 year to 3 years.
Hybrid Mutual Funds
The aim of hybrid funds is to bring stability by reducing the effect of market volatility, while generating growth. The presence of fixed-income instruments and gold in the portfolio provides stability, while that of equities ensures growth.
The horizon of investments in hybrid MFs would be 3 to 5 years.
However, to determine the exact category and exact funds that would meet your financial goals, you should consult a financial advisor before investing.