Mutual funds invest in a plethora of financial instruments like stocks, government and corporate bonds, debt instruments and gold, depending on the schemes’ mandate. However, as not all types of mutual funds may be suitable for every investor, one should know about the different kinds of mutual funds before investing, depending upon their risk appetite, goals and tenures.

Adhil Shetty, CEO, Bank-bazaar.com, says, “It is easier to shortlist the right investment product when your financial goals are clear. For short-term investment, you can go for less-risky debt funds. You might need the money; therefore, you cannot afford to take higher risks. On the other hand, if you have a long-term horizon, you might take some risk and invest in equity mutual funds for marginally higher returns. Evaluate your mutual fund options based on your investment objectives.”

Broadly, mutual funds are classified into two categories — equity schemes and debt schemes.

Equity mutual funds

Equity mutual funds are schemes which invest your money in the shares of several companies listed on the stock exchanges. The strategy of allocating assets across the companies helps investors reduce risks and benefit from growing a broader spectrum of businesses.

For instance, if you have put Rs 1,000 in an equity fund which invests, say, in 50 companies, you will have a proportionate ownership of all these companies in your portfolio. If a few stocks do not perform, the better-performing stocks in the portfolio would either negate or reduce the hit on your investment value. Thus, you have the advantages of diversification and getting risk-adjusted returns. However, equity is one of the riskiest and most unpredictable asset classes in the short to medium term. But a longer investment horizon tends to reward investors beating nearly all other investment avenues.

Data suggests equity funds have offered a CAGR of 18%-20% over the last two decades. In actual terms, a lump sum investment of Rs 1 lakh would have become Rs 38.33 lakh during the same period. Similarly, a monthly investment (SIP) of Rs 10,000 — an overall deposit of Rs 24 lakh during the last two decades — would have become a whopping Rs 2.48 crore. However, historical trends may not repeat, and that’s why returns from equity schemes are not guaranteed.

Equity mutual funds should be the preferred choice for those with moderate to high-risk appetites who want to benefit from stock markets but need more experience or time to track the markets actively. Equity schemes offer a reliable proxy to ride the growth story of an emerging economy.

Debt mutual funds

The debt category of mutual funds is relatively safer and more stable than its equity counterparts. However, in terms of long-term returns, they may be much less than what equity schemes offer. But debt funds tend to perform better when compared to banks’ savings accounts or traditional investment avenues like fixed, recurring, or postal deposits.

Debt mutual funds are also diversified schemes like equity. They invest mainly in a mix of debt or fixed-income securities, which include corporate bonds, government securities and Treasury Bills, among other debt papers. Thus, given the kind of instruments debt funds invest in, these are relatively less risky investments and much more predictable than equity investments.

FUND FACTS

* A longer investment horizon tends to reward equity investors beating other investment options

* Equity schemes offer a reliable proxy to ride the growth story of an emerging economy

* Investors at the fag-end of their working life must consider debt funds as these are relatively less risky investments