When mutual funds were first introduced in India, UTI was the only option available then. However, over the years, the industry has grown in leaps and bounds and today an investor has plenty of mutual fund schemes to invest in. It has gained importance as one of the key components that make an apt financial plan.
A mutual fund scheme has a unique risk profile that is determined by its portfolio. It generates good returns and also keeps the risk minimal in a stipulated time frame. Investing in a mutual fund scheme gives investors the benefits of a diversified portfolio, professional management, flexibility, and easy liquidity among others.
Mutual Fund Classifications:
Mutual fund schemes can be classified on the basis of maturity or the investment objective.
Schemes According To Maturity Period:
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on the maturity period.
Open-Ended Fund/ Scheme:
An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis and does not have a fixed maturity period. It gives investors the convenience to buy and sell units at Net Asset Value (NAV) related prices which are computed on a daily basis. Liquidity is the key feature of this scheme.
Close-Ended Fund/ Scheme:
A close-ended fund or scheme has a stipulated maturity period of say 5 to 7 years. The fund is open for subscription only for a specific period at the time of launch of the scheme. Investors can invest at the time of the initial public issue and thereafter they can buy or sell units of the scheme on the exchanges where the units are listed.
To provide an exit route to investors, some close-ended funds give an option of selling back the units to the mutual fund through a periodic repurchase. SEBI regulations stipulate that at least one of the two exit routes is provided to the investors i.e. either repurchase facility or through listing on stock exchanges. These schemes disclose the NAVs generally on a weekly basis.
Schemes According To Investment Objective:
A scheme can also be classified as a growth scheme, income scheme or a balance scheme based on its investment objective. These schemes may be open-ended or close-ended. They can be classified as follows.
Equity-oriented Scheme (Growth Funds):
The aim of growth funds is to provide capital appreciation over medium to long term. Such schemes normally invest a major part of their corpus in equities and have comparatively high risks. They provide different options to the investors like dividend and growth options depending on their preferences. The investors must indicate the option in the application form. This mutual fund scheme also allows investors to change the options at a later date. Growth schemes are good for investors with a long-term outlook seeking appreciation over a period of time.
Equity-oriented funds can be further categorized into:
Specialty Equity Funds: These funds have a narrow portfolio orientation and invest only in companies that meet the pre-determined criteria. The different kinds of funds that fall in this category are: sector funds that invest in only in a specific sector, global funds that invest in equities in one or more foreign countries thereby achieving diversification across the country's borders and others.
Equity Linked Saving Schemes (ELSS): The advantage of investing in such schemes is the tax benefit that an investor gets under section 80C of the Income-tax Act, 1961 up to Rs 1 lakh. These schemes have a lock-in period of minimum 3 years.
Diversified Equity Funds: A fund that seeks to invest only in equities, except for a very small portion in liquid money market securities, but is not focused on one or few sectors or shares may be termed as a diversified equity fund. While exposed to all equity price risks, these schemes seek to reduce the sector or stock specific risk through diversification.
Mid-cap or Small-cap Funds: These funds invest with relatively lower market capitalization than that of blue chip companies. This makes them more volatile at times than mid-size or smaller companies' shares that are not very liquid in the markets. Small company funds may be more risky due to their aggressive growth style.
Index Fund: Index funds replicate the portfolio of a particular index like the BSE Sensex and NSE 50 Index (Nifty) to name a few. These schemes invest in securities comprising the index and also in the same weightage. NAVs of index fund schemes rise or fall in accordance with the rise or fall in the index that they are replicating, though not exactly by the same percentage due to factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.
Income Or Debt-oriented Scheme: Income funds, as the name suggests, provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, government securities and money market instruments. They are less risky as compared to equity schemes. These funds are not affected by fluctuations in the equity markets.
However, the chances of capital appreciation are limited in such funds. The NAVs are affected due to changes in interest rates in the country. If the interest rates plummet, the NAVs of the schemes are likely to increase in the short run and vice versa.
Balanced Fund: Balanced funds give both growth and regular income as these schemes invest in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. These funds are also affected due to fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile as compared to pure equity funds.
Money Market Or Liquid Fund: Money Market or Liquid Funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposits, commercial paper and inter-bank call money, government securities and others. Returns on these schemes fluctuate lesser than other schemes. They are appropriate for individual investors who wish to park their surplus funds only for a short-term period.
Gilt Fund: Gilt funds invest exclusively in government securities and they have no default risk. The Net Asset Value (NAV) of these mutual fund schemes tend to fluctuate with changes in interest rates and other economic factors as is the case with income schemes or debt-oriented mutual fund schemes.
Investing In Mutual Funds Through Lumpsum Or An SIP:
As equities give sizeable returns in the long term, it is considered to be the eventual instrument to hedge an individual's savings against inflation. Mutual funds play a vital role for professional management of such investments and diversification of the risk exposure in a single company. One can look at investing in mutual funds either through a lumpsum amount or through a Systematic Investment Plan (SIP).
Lumpsum investment is investing all your money at one time. It is advantageous for an investor who has excess liquidity at his disposal. Lumpsum investment does not give the benefit of an SIP like rupee-cost averaging or the power of compounding.
SIP is a method of regularly investing a fixed sum in a mutual fund scheme. It is very similar to a regular saving scheme like a recurring deposit. A time-tested disciplined way of investing, an SIP allows you to buy units on a given date each month. Once the mutual fund scheme and the amount to be invested every month is decided, the investor can give post-dated cheques or ECS instructions and the investment will be made regularly. Thus small investments made over a period of time can help increase wealth and fulfill an individual's dreams of reaching the financial goals.
Benefits Of Investing In An Sip:
An SIP supports a disciplined approach towards wealth creation wherein a fixed sum invested each month makes it easy on the pocket of investors of different age groups with different incomes. Despite the current volatility in the market, such schemes spread risk and help protect wealth of an individual by preventing loss of value in case of excessive volatility in the bourses.
Since the option of regular and fixed interval payment is a feature of this product, SIP is more preferred than the traditional year end method of saving. In an SIP, regular payments are made, which brings to play the rupee cost averaging option, reducing the average cost per share over time.
When stock prices are low it gives investors an opportunity to buy more units of a mutual fund scheme and fewer units when stock prices are high. This way, market fluctuations can help an investor to benefit by investing in an SIP.
Saving a small sum of money regularly at an early stage allows the investor to reap benefits due to the power of compounding with significant impact on wealth accumulation. A Systematic Investment Plan provides maximum returns when investments are made for a longer period of time. Investors who follow this strategy gain from the compounding effect of returns on their investments made in mutual funds.
Depending on how long the investor wishes to stay invested and his investment objective, he can choose from the various options available to him. The option of investing a lumpsum or through an SIP gives an investor the flexibility to decide how much he should invest at one point. And if yet undecided about the right mutual fund scheme, just seek professional help of a financial advisor or a brokerage house who will not only help in taking the decisions but will also help you in making the appropriate investments.