What are Mutual Funds?

A mutual fund is a professionally managed fund that pools the savings from many investors (individuals, companies, trusts, etc.) who wish to save and grow their money. However, they want to invest in such a way that there money works harder for them. So, their money is pooled together and managed professionally. Now, this requires specialised skill’s.  To do this, some organisations create mutual fund schemes which are managed by professional fund managers. Fund Manager decides which stock or bond to buy and how much. A mutual fund then distributes the entire investment amount in small units (called units). Investors can buy these units instead of buying stocks directly.

Different Types of Mutual Funds

There are five types of mutual funds category as determined by capital market regulator Securities and Exchange Board of India (SEBI):

Equity Schemes – These mutual funds invest in equities and equity-related securities and offer comparatively highest returns but brings along a high degree of risk. The category is further divided based on portfolio composition such as multi-cap fund, large-cap fund, mid-cap fund etc.

Debt Schemes – This type of mutual fund invests in debt instruments of varying maturity and varied yield and risk level.

Hybrid Schemes – invest in a mix of stocks, bonds, and other securities.

Solution Oriented Schemes – These are schemes where there is a specific goal that is aimed at. For example Retirement fund, Children’s fund. In such schemes investment can be made in any asset class.

Other Schemes – This includes all funds which are not covered above. For example Exchange Traded Fund that seeks to replicate an index, hybrid funds that also invest in a group of other mutual funds and are popularly known as funds of funds etc.

Active vs. Passive

Irrespective of fees, category, an investment instrument, performance, each mutual fund is also classified into two categories namely – Active Funds and Passive Funds

Passive Funds – These funds invest as per pre-defined strategy and seek to match the performance of a specific market index. Thus these types of funds require little investment skill, little management, and low fees when compared to their counterparts actively managed funds.

Active Funds – These funds seek to outperform the market indices and have the potential to outperform the passively managed funds with high margins. These funds, however, comes with a cost i.e., management fees and is managed professionally by a team of analysts.