Types Of Mutual Funds One Should Know
Mutual funds in the last few years have emerged as a veritable savings instrument. Small and medium investors are increasing realizing that mutual funds offer their best bet to grow wealth consistently over time...
Mutual funds in the last few years have emerged as a veritable savings instrument. Small and medium investors are increasing realizing that mutual funds offer their best bet to grow wealth consistently over time. And when equity funds are combined with debt funds then you get professional management, risk management, liquidity and flexibility. That is what makes mutual funds an interesting proposition.
When it comes to mutual funds, there are some interesting classifications that you need to know as it will enable you to make more informed investment decisions.
Mutual Funds Classified By Their Structure
Based on their structure, mutual funds can be segregated into open-ended funds, closed-ended funds, and interval funds. What do they mean?
- Open-ended funds, as the name suggests, are open for investment and redemption through the year. There are no restrictions on the purchase and sale of mutual fund units. You can approach the fund and you can buy or sell the funds at the prevailing NAV of the fund. On a daily basis, the funds are required to disclose their NAV, sale price and their repurchase price.
- Closed-ended funds are funds that are closed for subscription and redemption once the initial offer for collecting funds is completed. Typically, if the closed-ended fund has a lock-in period of 3 years and then you can redeem the fund only after 3 years. FMPs are the common form of closed-ended debt funds. Morgan Stanley Growth Fund (MSGF) was one of Indiaâs earliest closed-ended equity funds.
- Interval funds are closed-ended funds which allow fresh purchase and redemption at regular intervals. These funds are not very popular in India.
Mutual Funds Classified By Asset Class
Another way of classifying mutual funds is based on their exposure to asset classes. There are 3 categories as under:
- Equity funds are those that are predominantly invested in equities and stocks. Of course, all equity funds to keep a small portion in cash/liquid funds so that they can capitalize on opportunities and also have enough cash to handle any redemption pressure. They are highest on the return and risk scale.
- Debt Funds are predominantly invested in debt instruments. Debt funds are essentially based on maturities and on credit quality. Debt funds can range from funds that are meant to park money for a few days to funds that park money in long-dated instruments. Debt funds also safe in safe government debt to higher risk âAAâ rated debt for higher returns.
- Balanced funds offer a mix of equity and debt in different proportions depending on your return requirement and your risk appetite. Balanced funds are lower on the risk scale compared to equity funds but higher on the risk scale compared to debt funds.
Mutual Funds Classified Based on Plans
These plans are sub-categories for each scheme. For example, equity funds and debt funds have sub-plans of their own depending on client requirement.
- Growth plans are quite common among investors looking at long-term wealth creation. In a growth plan, all returns earned by the fund are reinvested back into the fund. Hence the NAV of the fund keeps growing over time. In fact, for those investors who are looking at equity funds from a long-term financial perspective, growth plans are the best option as there is automatic reinvestment which leads to long-term wealth creation.
- Dividend plans are a variant of the growth plan where the returns are partly paid out to the investors in the form of dividends. These dividends are value neutral as they are paid out of the existing corpus of the fund only. For example, if the NAV of the fund is Rs.45 and the fund pays out Rs.4 as dividends, then the NAV of the growth plan remains the same but the NAV of the dividend plan will fall by Rs.4 to Rs.41. Dividend plans are not suited for long-term wealth creation. Also, from a tax point of view, dividends attract dividend distribution tax (DDT) making them uneconomical.
Finally, in a reinvestment plan, the dividends are paid out but instead of paying out in cash, these are reinvested as units. The NAV of a reinvestment plan is the same as a dividend plan but the units will be higher and the value of the fund will be the same as a growth plan. This plan is not too popular as investors are more comfortable with a discrete choice between growth and dividends.