Mutual Fund Investments Plans and How They Work

If you are someone who wishes to create wealth, chances are that you know about Mutual fund
investment plans. These investment vehicles are one of the best ways of wealth creation and hence,
are growing in popularity. Mutual funds have the potential to yield attractive returns for the investor
in comparison to traditional forms of investment such as gold, bank deposits, etc.

How do mutual funds work?

Mutual funds collect money from many investors and invest it in securities such as bonds, stocks,
money market instruments, etc., according to the investment objectives of the fund. As a result of
the investment, investors achieve capital appreciation. The assets of a mutual fund are managed by
professionals known as fund managers who manage the fund on a day-to-day basis. Fund managers
buy and sell the securities in accordance with the fund’s investment objectives.

What are the types of mutual funds?

Mutual funds are mainly classified into the following types:

Equity Funds - Mutual funds that invest in the stocks of companies are called equity funds and they
are further classified into large cap, mid cap, and small cap equity funds. Large cap equity funds
invest in stocks of large cap firms (firms ranked 1 to 100 in terms of market capitalisation), mid cap
funds invest in stocks of mid cap firms (firms ranked 101 to 250 in terms of market capitalisation),
and small cap funds invest in stocks of small cap firms (firms ranked above 250 in terms of market
capitalisation). Check also Derivatives trading course

Debt Funds - These funds invest in debt securities such as bonds, government securities,
debentures, treasury bills, etc., to generate capital gains for the investor. Debt funds offer low risk
and hence, are ideal for conservative investors. These funds also offer high liquidity and are suitable
for investors who wish to invest for a short term or medium term horizon. A short-term investment
horizon can range between 3 months and 1 year while a medium-term horizon can range between 3
years and 5 years. Debt funds are further classified into dynamic bond funds, liquid funds, income
funds, gilt funds, short-term and ultra short-term funds, credit opportunities funds, and fixed
maturity plans.

Hybrid Funds - Mutual funds that invest in a mix of securities (debt and equity) are known as hybrid
funds. When a fund invests 65% or more of its corpus on equities, it is known as an equity-oriented
fund and when 65% or more of a fund’s corpus is invested in debt securities, it is known as a debt-
oriented fund. Hybrid funds are ideal for budding investors who wish to derive gains from equities
but do not want to be burned out by the fluctuations in the equity market. The debt component of
these funds can act as a cushion and offer stable returns to the investor.
Index Funds - A mutual fund that mimics an index such as the Sensex or Nifty is known as an index
fund and is a passively managed fund. An index fund will consist of the same stocks that constitute
the index it mirrors and in the same proportion. These funds deliver returns that are more or similar
to the returns delivered by the benchmark indices but sometimes, there may be slight variations.
This is known as tracking error and is the difference between the performance of the fund and the
performance of the benchmark index. Fund managers always strive to minimise the tracking error on
the index funds.

Fund of Funds - Mutual fund schemes that invest in other mutual fund schemes are known as Fund
of Funds (FoF). These funds offer tax-friendly rebalancing of investors portfolio and are ideal for
small investors who have a low tolerance towards risk.