Planning your investments while keeping your financial goals in mind is an effective way to meet your short-term, medium-term, and long-term goals in a seamless and timely manner. When you know what goal you are working towards, it becomes clear how much you should invest, for how long, and in which instrument, allowing you to invest strategically.
Mutual funds are one of the most helpful investment instruments to undertake goal-based investing. Given the various types of mutual funds across asset classes and the benefits like professional management, the option to invest through SIP (Systematic Investment Plans), and diversification, they make for a great addition to your investment portfolio.
For each type of goal, risk tolerance, and investment horizon, there is a type of mutual fund out there. Hence, it’s essential to map out your financial goals, understand the different types of mutual funds available, and pick the one that best aligns with your goal.
Definition and structure of mutual funds
A mutual fund is an investment instrument that pools money from various investors and then invests in certain assets like stocks, bonds, etc., to help meet the investment objective of the investors. The way mutual funds are structured provides two inherent advantages – diversification and professional management.
A mutual fund scheme does not solely invest in one instrument. For instance, an equity mutual fund would invest in stocks of multiple companies instead of just one company. This helps reduce risk as the performance of the fund is not dependent on one individual instrument alone. Additionally, every mutual fund has a mutual fund manager who is an expert responsible for making all the crucial decisions, such as what to buy, when to buy, when to sell, how long to hold, etc.
Advantages and benefits of mutual funds for investors
- Goal-based investing: Mutual funds allow you to undertake goal-based investing. For example, if you have a long-term goal of building a retirement corpus, you can invest in equity mutual funds.
- Professional management: Since fund managers manage the portfolio to maximise returns and minimise risks, it saves you time and effort. You don’t have to constantly monitor the markets or be very well-versed with the markets to benefit from them.
- Liquidity: Most mutual fund types offer high liquidity and come without any lock-in periods. You can sell your mutual fund units at any time and get access to your money whenever required.
- Convenience: Mutual funds not only offer a wide range of options when it comes to the kind of schemes you can invest in but also offer the convenience of investing through SIPs. SIPs allow you to automate your investments and build wealth over the long term through small, periodic investments.
- Diversification: Investing in mutual funds helps mitigate portfolio risk as your money is spread across securities and asset classes.
Role in portfolio diversification and risk management
A well-built portfolio set for gains is always a well-diversified portfolio. And mutual funds help diversify across levels. First, you can diversify across asset classes by investing in the different categories of mutual funds – equity, debt, and hybrid. Second, you can diversify across instruments, sectors, and market caps. Third, you can diversify across geographies by investing in international funds and gain exposure beyond the domestic market.
Types of mutual funds
As per the categorisation of the Securities and Exchange Board of India (SEBI), here are all the types of mutual funds available:
1. Equity mutual funds
These funds invest in the stocks of companies and are further categorised into:
- Large-cap fund
- Small-cap fund
- Mid-cap fund
- Multi-cap fund
- Flexi-cap fund
- Dividend yield fund
- Value fund
- Contra fund
- Focused fund
- Sectoral and thematic funds
- Equity-Linked Savings Scheme (ELSS)
2. Debt funds
These mutual funds invest in fixed-income securities and money market instruments and include the following subcategories:
- Liquid fund
- Ultra-short duration fund
- Low duration fund
- Money market fund
- Short duration fund
- Medium duration fund
- Medium to long duration fund
- Long duration fund
- Dynamic bond
- Corporate bond fund
- Credit risk fund
- Banking and PSU fund
- Gilt fund
- Gilt Fund with 10-year constant duration
- Floater fund
3. Hybrid funds
These funds invest in both equity and debt instruments and are of seven types:
- Floater fund
Hybrid funds
These funds invest in both equity and debt instruments and are of seven types:
- Conservative hybrid fund
- Balanced hybrid fund
- Aggressive hybrid fund
- Dynamic asset allocation or balanced advantage fund
- Multi asset allocation fund
- Arbitrage fund
- Equity savings
Solution-oriented and other funds
Besides equity, debt, and hybrid funds, here are some more types of mutual funds:
- Retirement fund
- Children’s fund
- Index funds
- Fund of funds
Aligning mutual funds with financial goals
To choose the right types of funds for your financial goals, here are some things to consider:
1. Short-term vs long-term investment objective
Some mutual fund types, like equity funds, are better suited for long-term investment objectives like wealth generation. So, you need to classify your financial goals into short-term and long-term to pick the right type of fund accordingly.
2. Risk tolerance and investment horizon
When picking the right mutual funds, it’s essential to consider your risk tolerance and investment horizon, which may differ for each goal. For example, for a goal like buying your first home, your investment horizon may be long and hence, so would your risk tolerance. It’s important to note that risk tolerance also depends on your financial obligations, income, age, and personality.
3. Matching fund type with specific financial goals
Once you have your financial goals, risk tolerance, and investment horizon mapped out, you can pick a fund type that aligns with it. For instance, if you have a short-term goal of building and parking your emergency fund for which your investment horizon is six months or less and your risk tolerance is moderate, you can pick debt funds like liquid funds.
The bottom line
Strategically investing involves link each financial goal to a specific investment instrument and building a well-diversified portfolio. And mutual funds help do just that. Such goal-based investing through mutual funds makes the process of investing a lot easier and more efficient. By understanding the right type of fund for your financial goals, you can make your money work optimally for you.
CAclubindia
