'The best argument for Mutual Funds is that they offer safety and diversification. But they don' t necessarily offer safety and diversification.' - Ron Chernow
With this quote, it is quite apparent that mutual funds have always been a subject of debate and hence, the idea of this article is to enlighten more and more people with the different kinds of mutual funds and when to choose which one.
Illustrious of all - Equity Mutual Funds
Equity mutual funds, which are the most famous mutual funds, are principally the funds in which people invest in stocks which could be managed either actively or passively. Actively managed mutual funds are essentially those in which one scans the market and challenges the price of the stocks and trust their valuations better than the market' s price and hence, strategize on whether to buy or sell a particular stock on the basis of their valuations and judgments.
Passively managed funds, on the other hand, are the ones which are just to replicate the returns on an index. They trust the prices of the market and are essential, buy and hold investments. Equity mutual funds by large is the most feasible investment vehicle. Mutual funds are an easy way to take the benefits of diversification for people who don't have huge capital to invest. Moreover, these are transparent as the past performance of the mutual fund managers is a matter of public record. Equity mutual funds are further sub-divided on the basis of market capitalization- large cap, mid cap and small cap.
Safest of all - Debt Mutual Funds
Having talked about equity mutual funds, we shall further our discussion with debt mutual funds. Debt mutual funds are the funds which the underlying is fixed income securities. Debt funds have to be a better fit for investors with a low-risk bandwidth or for those who are looking for preservation of capital. The fee for the mutual fund managers on the fixed income funds are less than that of equity funds as these securities doesn't require much of management.
The underlying fixed income securities could be government bonds, corporate bonds etc, however, the perk of little or no risk from the fixed income funds come from either the government or because of the credit ratings for the corporate fixed income securities.
Jack of all - Hybrid Mutual Funds
We precede our discussion with the Hybrid Mutual Funds which quite evidently as the name suggests is one which has both a component of stocks as well as a fixed market instrument. These could be well-suited for individuals who have a little appetite for risk and therefore, capital appreciation but simultaneously are also looking for safety. Hence, it could be tailored according to the needs and the investment policy statement. Balanced Funds are also a type of hybrid funds.
Index Mutual Funds
The fourth type of mutual funds are the Index mutual funds. These are the ones that are constructed in a manner to match the performances to a particular index, for e.g., the S&P500. Since such mutual funds are passively managed they do not have a high managing fee and therefore, low operating expenses. On an average, a passively managed fund has an expense ratio of 0.2% whereas for that of an actively managed fund, it is 2%. Index funds could track the performances of both stock indexes like the S&P500 or the bond indexes like the Barclays Capital Aggregate Bond Index. Some might think since these are passively managed, they're risk-free, however, there' s a chance of a tracking error in these funds in which cases, they might not be able to mimic the performance of the index fund.
Specialty Funds - The name says it all
We would now extend our discussion to the Specialty Funds which are the funds that specifically are known for investing in a particular industry or simply, special types of securities such as Infrastructure Sector, Pharma Sector, Real Estate Sector. These are also referred to as ' sector funds'.
According to the recent categorization by SEBI, the mutual funds can be put in five categories - equity, debt, hybrid, solution-oriented and others. Solution-oriented funds are primarily to offer people with a way to cover their goals like: retirement, dream home or child' s education.
Hence, there is a small variety but vast pool of mutual funds and hence, an investor can choose from these to fulfil their unique and specific needs. However, choosing a mutual fund involves a lot of different aspects including their fund size, expense ratio, fund managers, portfolio etc. In the coming days, I will be writing more about mutual funds and their various aspects.
Please share your comments and questions below.