Most of us love to have options. Options give us the choice to select the right option from different options. Mutual Funds come in different shapes and sizes. Mutual funds can be segregated into different categories based on assets, liquidity etc.
Based on underlying assets, mutual funds can be divided into three major types of funds: equity mutual fund, debt mutual fund and hybrid mutual fund.
This is one of the most popular categories of mutual funds. Equity funds invest in shares issued by different companies in the equity markets. The main objective of equity funds is to create wealth. Also, these funds have shown to deliver higher returns in the long run. Hence, it is a good investment option for your financial goals with a long term horizon of more than five years.
Another factor that you need to keep in mind before investing in an equity fund is your risk-taking capacity. In the short term, equity funds come with higher risk and are prone to frequent fluctuations. Hence, if you haven’t invested in equity funds earlier, you should invest after doing your research or consult a financial advisor. However, the risk associated with equity funds is averaged out in the long term.
There are different types of equity funds as well. Large-cap funds, mid-cap funds, small-cap funds, value funds are some of the popular types of equity funds. The constituents and the risk associated with these equity funds will vary from one category of equity fund to others. E.g., small-cap funds are riskier than large-cap funds.
Equity-Linked Savings Scheme (ELSS) is a category of equity mutual funds that helps you to save tax as well. Investors are eligible for tax deductions of up to Rs. 1.5 lakh under the Income Tax Act in a financial year. These funds give the benefits of both tax saving and wealth creation. However, it comes with a lock-in of three years, which is the lowest among all the different types of equity funds.
Debt Funds are the mutual funds that do not invest in the stock market. They invest in debt securities issued by the central government, state government and other companies. These securities are less volatile than equity funds. However, you need to keep in mind that the debt funds do not assure a fixed rate of interest like fixed deposits.
Capital protection along with moderate returns is the basic objectives of these funds. It is effective for short term financial goals with a time horizon of one day to three years. Debt funds can also be classified into various types. Liquid funds, ultra short term funds, income funds, gilt funds and credit risk funds are some of the types of debt funds. The risk associated with the different debt funds also varies.
Short term capital gains and long term capital gains tax applies to debt funds. Short term capital gains are applicable for investments that are held for less than three years and long term capital gains if the investments are held for more than three years. Short term capital gains are taxed as per the income slab of the individual. Long term capital gains are taxed at 20% after indexation benefits. Indexation takes the inflation rate in the year into account while calculating the gains. Hence, the tax will only be applicable on the return is given by the debt fund which is more than the rate of inflation.
As the name suggests, these types of mutual funds invest in both equity and debt asset classes. These hybrid funds will invest in both equity and debt securities in a certain proportion. Equity-oriented hybrid funds have a higher equity allocation of at least 65% while debt-oriented funds have a higher debt allocation. Hence, hybrid funds are suitable for a large number of investor. For investors, who don’t want to take 100% allocation in equities and want the stability of the debt instruments, can look at investing in equity-oriented hybrid funds.
For conservative investors, equity savings mutual funds help to tackle the volatility in the stock market as well as to get higher returns from the equity allocation.
These were some of the major types of mutual funds. So what are you waiting for? Go ahead and invest in a mutual fund that is aligned with your risk tolerance and financial goals.
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