Investing in mutual funds is becoming popular among Indian investors. As most people seek to diversify their investment portfolio across various asset classes to minimise systematic risk, mutual funds are a great investment option that one can look into.

As people look at mutual funds with special interest, there are various important points and tips that they need to be aware of.

Understanding Mutual Funds

A mutual fund pools the money of various investors and invests it across different investment categories like bonds, money market instruments, stocks, and other types of securities. This means that a proportional share of the fund’s losses, income, gains and expenses goes to the owner of a mutual fund unit. Further, each mutual fund has a specific objective which is stated in the fund’s prospectus.

The mutual funds are managed and put together by an Asset Management Company (AMC) which may have several schemes with similar or varied investment objectives. An AMC hires different portfolio managers who are experts in buying and selling securities in accordance with the fund's stated objective.

Common Types of Mutual Funds

Broadly, mutual fund schemes can be open-ended or close-ended. While in an open-ended scheme, an investor can invest or redeem at any point of time, close-ended mutual funds have a fixed maturity date. Now, let’s explore various types of mutual funds available in the market.

1. Fixed Income Funds

Such mutual funds pay a fixed rate of return to investors. The investment is made usually in investment-grade corporate bonds, government bonds, and high-yield corporate bonds. They are the best fit for investors who want to have regular and fixed amounts coming into the fund. Further, out of all the investment options that fixed-income funds cater to, high-yield corporate bond funds are generally riskier than investment-grade bonds or funds that hold government bonds.

2. Money Market Funds

Treasury bills, government bonds, commercial paper, bankers’ acceptances and certificates of deposit are some of the short-term fixed income securities in which these funds invest. Though they have a lower potential return, they are generally a safer investment.

3. Equity Funds

Equity funds invest in stocks, aiming to grow faster than fixed-income funds or money market. With potentially higher return chances, these funds are also riskier. The different types of equity funds include growth stocks, income funds, value stocks, large-cap stocks, small-cap stocks, mid-cap stocks, or combinations of these.

4. Commodity Funds

Commodity funds are of pro-cyclic nature which means their prices move together with macroeconomic growth and inflation which enables the investors to offset against a possible decline in the value of their savings as a result of the increase in commodity prices. Moreover, commodities typically have a low correlation with other asset classes which increases their ability to be excellent portfolio diversifiers.

5. Index Funds

These funds track the performance of a particular index and as a result, the value of the fund will increase or decrease as the index goes up or down. These funds typically are less costly than actively managed mutual funds. This is because the portfolio manager doesn't have to invest much time in research or make as many investment decisions.

Diversify by Investment Style

To meet the investment objectives of a fund, portfolio managers may use different styles of investing which enables diversification beyond the type of investment and ultimately, reduces investment risk. Some common approaches to investing are the top-down approach, the bottom-up approach, a combination of top-down and bottom-up approaches, and technical analysis i.e. forecasting the investment prices by studying past market data.

Summing Up!

Given the popularity and proliferation of mutual funds in the market, they can be the most effective medium for enabling investors to access multiple asset classes such as equity, debt, and gold. It provides the investor with unique benefits, as well as, helps them to create wealth along the way.

The author is the Senior Vice President, Master Capital Services

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.