The two types of Mutual Funds you should know about

Types of Mutual Funds

We often make choices in life that can’t be justified by logic. We like movies our friends might hate, or we want to drive a particular motorcycle simply because it looks cool and macho to us. Most of the time, such choices are harmless.

However, when it comes to investing, choosing investments without having a logic can end up being detrimental to your wealth. You need to understand what goal you are investing towards and how Mutual Funds can help you achieve it.

There are different types of mutual funds that can help you achieve different types of goals. To begin with, there are two major kinds of funds that anyone who is going to think about investing, should know about.

Equity Mutual Funds

These are the most popular type of mutual funds and what you mostly hear about.

What do they invest in?

Such mutual funds invest in shares of different companies which are listed on a stock exchanges such as the Bombay Stock Exchange or National Stock Exchange.

What do they help you with?

Equity mutual funds can help you grow your money at a rate that beats inflation. This makes such mutual funds ideal for goals which are many years away, such as funding your retirement or saving for your child’s education.

What should you keep in mind when investing in them?

Equity mutual funds tend to fluctuate in value, because the shares they invest in are traded in a stock exchange on a daily basis. The price of such stocks and shares thus changes on a daily basis, which is why the value of the mutual fund also changes. As markets go up or down, so do equity mutual funds.

Such movements though are short term and in the long-term equity mutual funds tend to go up and at a rate which other investments like bank deposits, bonds, money market instruments etc. cannot match. Thus, if your goal is years away and you want to stay ahead of inflation, equity mutual funds are a good choice.

Debt Mutual Funds

These are the not as well-known as equity mutual funds type, but they are incredibly useful in meeting a lot of our savings goals.

What do they invest in?

Debt funds invest in debentures, corporate and government bonds, certificate of deposits, money market instruments etc. All these instruments are collectively known as fixed income instruments because they generate an interest similar to what a bank fixed deposit does. Debt funds do not invest in stocks.

What do they help you with?

Debt funds are perfect for short term goals that are up to 0-3 years away. Because they don’t fluctuate as much as equity funds in value, they are ideal for goals where surety is more important than growth. For example, if you are planning to take a vacation to Bali two years from now, you can use a debt fund to save for it.

What should you keep in mind when investing in them?

Debt funds generally grow at a rate that is either at par with inflation or slightly more. This means they don’t grow as much as equity funds. But the slow pace means that they are far more stable in terms of value. You are unlikely to see big ups or big downs when investing in debt funds. This is why if your goal is 0-3 years away, debt funds make a lot more sense.

A few other things to keep in mind

There is also a third sort of mutual fund known as a hybrid fund which invests in both debt and equity. Their performance is somewhere in between that of a pure equity fund and a pure debt fund. Some people prefer it, as they find it a good compromise between the growth of equity and the stability of debt. However, if your goals are clear then it’s generally better to invest separately in both equity and debt funds for those goals.

Another thing you should keep in mind is that mutual funds gains are taxed less than other types of investments. If you hold equity mutual funds for longer than a year, then the gains will be taxed at the rate of 10%. This tax will only apply to the gains that are over a lakh. In case of debt funds, if you hold for longer than 3 years then your gains are taxed at 20% with indexation benefit, which can bring down the tax a lot.

While there are even more kinds of mutual funds, most of them are variations of the two described here. If you know about equity mutual funds and debt funds, you are all set to get started with your investment journey. It’s now time to act.

 


 

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Read up more on Mutual Funds here

Mutual Fund investments are subject to market risks, read all scheme related documents carefully before investing.



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