modified on 27.08.2016
What are Mutual Funds?
A mutual fund is a financial intermediary that pools funds of a group of investors and invests the pooled money with a predetermined investment objective. All mutual fund have a fund managers who take decisions regarding investing the collected money into specific securities i.e. equity shares, debentures, bonds or other securities. A person on investing in a mutual fund, buys units or shares of the mutual fund and thus he or she becomes a unit holder or share holder of the fund.
Types of Mutual Funds
Mutual funds can be classified under various categories on the basis of their structure and objective. Some major types are listed below :
Categories by structure:
- Close Ended Funds: Close ended mutual funds have a set number of units or shares. These funds usually open for subscription only at the time of the initial public issue and thereafter the investors can buy or sell the units/shares of the fund on the stock exchanges where they are listed.
- Open Ended Funds :
Open ended mutual funds do not have a set number of units or shares. These funds continue to sell units or shares to investors and also buy back units or shares when investors wish to sell. Units are bought and sold at their current Net Asset Value (NAV).
- Interval Funds: Interval Funds are a mix of Close Ended and Open Ended type of funds. After the initial public issue, the units of the fund may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
Categories by Return:
- Regular Income
These mutual funds provide regular income at a rate announced from time to time and also provide prospect of capital appreciation.
- Deferred Income
These mutual funds provide capital appreciation with or without bonus on maturity.
- Tax Saving
These mutual funds enable the investors to take advantage of of deduction available under Section 80C. Besides there can be appreciation in the value of the units.
Categories by Objective:
- Equity Funds or Stock funds:
Equity or Stock funds invest the pooled money in stocks of public companies. Many mutual funds invest primarily in large, medium and small sized companies and are accordingly classified as large-cap, mid-cap or small-cap funds.
- Growth Funds: Growth funds invest their pool of funds in companies experiencing significant earnings or revenue growth rather than in good dividend paying companies. The managers of the these funds may take more risk in building portfolio of fast growing stocks. Generally, these funds carry relatively higher risk and are more volatile.
- Index Funds: An index fund builds its portfolio by buying stock in all the companies of a particular index. The fund, therefore, produces the performance of an entire section of the market.
- Monthly Income and Income Funds: These funds invest the pooled money predominantly in regular income generating debt securities such as bonds, corporate debentures, Government securities and money market instruments. These funds provide regular income/dividend to investors.
- Value Funds:Value funds invest their pool of funds in good dividend paying companies. They put more emphasis on income than growth. These funds produce regular income and also some capital growth over relatively longer period of time.
- Equity Linked Tax Saving Funds: These funds invest the pooled money in equity, and offer tax deduction to investors under section 80 C of the Income Tax Act. These funds usually have a lock-in period of minimum three years.
- Sector Funds: Sector funds invest their pool of funds in a particular sector of segment of the economy. These funds lack diversification and are more volatile and may produce huge gains or losses.
- Balanced Funds: Balanced funds invest their funds in a combination of diversified stock, bonds, and short-term bonds, to provide both income and capital appreciation while avoiding excessive risk.
- Money Market Mutual Fund: Money Market Mutual funds invest their funds in money market instruments i.e. debts that mature within one year and very liquid like treasury bills. The investment in these funds is considered most safe and secure. The return on investment is generally lower than that on other types of funds.
- Regional Mutual Funds: These funds make investment in securities of companies from a particular geographical region to take advantage of the potential of economic growth in the region.
- International Mutual Funds: These funds invest their pool in overseas stock markets and provide greater diversified portfolio. International mutual fund may be profitable when some markets are rising and others are declining. The movement of foreign currencies of the countries in which investments against dollar also plays a vital role in these case of these funds.
- Fund of Funds: A fund of funds invests its money in other mutual funds. Just as a mutual fund invests in a number of different securities, a fund of funds holds shares of many different mutual funds and hence provides more diversification to investors.
Mutual Funds and Tax Saving
- The amount invested in Equity Linked Savings Schemes is eligible for exemption from Income Tax under Section 80C of Income Tax Act. These schemes generally have a lock in period of three years.
- The dividend income received on mutual funds is exempt from income tax in the hands of the investor.
- Long term capital gain tax is available on income due to appreciation of value of units of mutual funds.