“Successful investing is about managing risk, not avoiding it”
~ Benjamin Graham
What Is Mutual Funds?
A mutual fund is a professionally managed financial instrument that pools money from many investors to purchase securities such as stocks, bonds, money market instruments, etc. The objective of every Mutual Fund scheme is clearly defined and explicitly mentioned by the Mutual Fund Company. In simple words, one can think of a Mutual Fund as a company that brings together a group of people and invests their money in stocks, bonds and other securities. Each investor owns units, which represent a portion of the fund, based on the amount invested by the respective investor.
Types of Mutual Funds
Equity funds aim to generate high returns by investing in the shares of companies of different market capitalization. Thus, performance of the funds would be linked with the performance of the invested companies. In other words, risk would be higher, however; due to diversification, the risk is brought down. Also, over a longer period the risk gets spread out and volatility in returns is averaged out hence investor gets higher returns than debt funds and fixed deposits.
Examples of equity funds are: Largecap Funds, Multicap Funds, Midcap Funds and Smallcap Funds.
A debt fund invests in fixed interest generating securities like corporate bonds, government securities, treasury bills, commercial paper and other money market instruments. The aim is to generate steady returns while preserving the capital; a feature that brings stability to the portfolio. All mutual funds carry some risks; however debt funds are less risky than Equity Funds.
Examples of debt funds are: Liquid Funds, Short duration Funds, Gilt Funds etc.
Hybrid funds are a mixture of Debt and Equity funds as these funds invest in both debt instruments and equities. These funds will be less risky than 100% equity funds due to the safety net provided by the debt component but more volatile than debt funds.
Examples of hybrid funds: Equity oriented hybrid, Debt oriented hybrid etc.
There are many more fund types like ETF Fund, Arbitrage Funds, Index Fund, Sectorial Fund, Special Situation Funds etc. Different investment philosophies use different styles of investing to meet the investment objectives of a fund. Choosing funds with different investment styles allows you to diversify beyond the type of investment. It can be another way to reduce investment risk.