Investing your money wisely is one of the most important financial decisions you can make. Among the various investment options available to Indians today, mutual funds have emerged as a popular choice for both beginners and experienced investors.
But with hundreds of mutual fund schemes available in the market, understanding the types of mutual funds in India and selecting the right one can be overwhelming.
This comprehensive guide will walk you through everything you need to know about mutual fund types in India, how they work, and how to choose the best mutual funds for your investment goals. Whether you're planning for retirement, saving for a down payment on a house, or building wealth for the future, this article will help you navigate the world of mutual funds with confidence.
What Are Mutual Funds?
Before diving into the different types of mutual funds in India, let's understand what mutual funds actually are.
A mutual fund is a professionally managed investment vehicle that pools money from many investors to purchase securities such as stocks, bonds, and other assets. When you invest in a mutual fund, you're buying units of the fund that represent a portion of its holdings. The value of these units, known as the NAV of mutual funds (Net Asset Value), changes daily based on the performance of the underlying securities.
The key advantages of investing in mutual funds include:
- Professional Management: Experienced fund managers make investment decisions on your behalf
- Diversification: Your money is spread across various securities, reducing risk
- Affordability: You can start investing with as little as ₹500 through a SIP investment (Systematic Investment Plan)
- Liquidity: You can redeem your investments easily when needed (except for certain types with lock-in periods)
- Transparency: Regular updates on fund performance and holdings
- Regulated Industry: All mutual funds in India are regulated by SEBI (Securities and Exchange Board of India)
SEBI Mutual Fund Classification
In 2017, the Securities and Exchange Board of India (SEBI) introduced new norms to standardize mutual fund categories SEBI to make it easier for investors to compare similar types of schemes. Under these regulations, a fund house can have only one scheme per category, with a few exceptions.
SEBI has broadly classified mutual funds into the following categories:
- Equity Mutual Funds
- Debt Mutual Funds
- Hybrid Mutual Funds
- Solution-oriented Funds
- Other Funds (Index Funds, ETFs, Fund of Funds)
Let's explore each of these categories in detail.
Equity Mutual Funds India
Equity mutual funds India primarily invest in stocks of companies listed on the stock exchanges. These funds have the potential to deliver higher returns compared to other fund types over the long term but also come with higher risk. Based on the market capitalization of the companies they invest in, equity funds are further classified into:
1. Large-Cap Funds
These funds invest at least 80% of their assets in large-cap companies, which are the top 100 companies in India by market capitalization. Large-cap companies are well-established and typically have stable businesses, making these funds relatively less volatile compared to other equity funds.
Risk Level: Moderate
Suitable for: Investors seeking capital appreciation with moderate risk
Investment Horizon: 5+ years
2. Mid-Cap Funds
Mid-cap funds invest at least 65% of their assets in mid-cap companies, which are ranked from 101 to 250 in terms of market capitalization. These companies have the potential for higher growth compared to large-caps but come with higher volatility.
Risk Level: High
Suitable for: Investors with higher risk appetite seeking better returns
Investment Horizon: 7+ years
3. Small-Cap Funds
Small-cap funds invest at least 65% of their assets in small-cap companies, which are ranked 251st and below in terms of market capitalization. These companies have the highest growth potential but also the highest risk.
Risk Level: Very High
Suitable for: Aggressive investors with high risk tolerance
Investment Horizon: 7-10+ years
Understanding the differences in large-cap vs mid-cap funds is crucial for aligning your investments with your risk profile.
4. Multi-Cap Funds
Multi-cap funds invest across market capitalizations with a minimum investment of 25% each in large-cap, mid-cap, and small-cap stocks. This provides investors with exposure to all market segments.
Risk Level: Moderate to High
Suitable for: Investors seeking diversification across market caps
Investment Horizon: 5+ years
5. Flexi-Cap Funds
Unlike multi-cap funds, flexi-cap funds can invest across market caps without any minimum allocation restrictions. The fund manager has the flexibility to adjust the portfolio based on market conditions.
Risk Level: Moderate to High
Suitable for: Investors who trust the fund manager's ability to time market segments
Investment Horizon: 5+ years
6. Sectoral/Thematic Funds
These funds focus on specific sectors (like banking, healthcare, technology) or themes (like consumption, infrastructure). They provide concentrated exposure to particular segments of the economy.
Risk Level: Very High
Suitable for: Investors with sector-specific insights or thematic investment strategies
Investment Horizon: 7+ years
7. ELSS (Equity-Linked Savings Scheme)
ELSS funds are tax-saving mutual funds that invest primarily in equities. They qualify for tax deductions up to ₹1.5 lakh under Section 80C of the Income Tax Act. ELSS tax saving funds come with a mandatory lock-in period of 3 years, the shortest among all tax-saving instruments under Section 80C.
Risk Level: Moderate to High
Suitable for: Investors seeking tax benefits along with capital appreciation
Investment Horizon: 3+ years (mandatory lock-in of 3 years)
8. Value Funds and Contra Funds
Value funds invest in undervalued stocks with potential for price appreciation, while contra funds invest against prevailing market trends.
Risk Level: High
Suitable for: Investors with higher risk appetite and longer time horizon
Investment Horizon: or 7+ years
Debt Mutual Funds India
Debt mutual funds India primarily invest in fixed-income securities such as government bonds, corporate bonds, treasury bills, and other money market instruments. These funds are generally less volatile than equity funds and aim to provide regular income to investors.
1. Overnight Funds
These funds invest in securities with a maturity of one day, making them one of the safest debt fund categories with minimal interest rate risk.
Risk Level: Very Low
Suitable for: Parking very short-term surplus funds
Investment Horizon: Few days to a few weeks
2. Liquid Funds
Liquid funds invest in debt securities with maturities up to 91 days. They offer better returns than savings accounts while maintaining high liquidity.
Risk Level: Low
Suitable for: Short-term parking of emergency funds or surplus cash
Investment Horizon: Few weeks to 3 months
3. Ultra Short Duration Funds
These funds invest in debt securities with maturities between 3-6 months and aim to provide slightly higher returns than liquid funds.
Risk Level: Low
Suitable for: Short-term investment needs
Investment Horizon: 3-6 months
4. Low Duration Funds
Low duration funds invest in debt securities with an average maturity of 6-12 months.
Risk Level: Low to Moderate
Suitable for: Investors with slightly longer investment timeframes
Investment Horizon: 6-12 months
5. Money Market Funds
These funds invest in money market instruments like treasury bills, commercial papers, and certificates of deposit with maturities up to one year.
Risk Level: Low
Suitable for: Conservative investors seeking better returns than savings accounts
Investment Horizon: 3-12 months
6. Short Duration Funds
Short duration funds invest in debt securities with a duration of 1-3 years, aiming for moderately higher returns.
Risk Level: Moderate
Suitable for: Investors who can tolerate some volatility
Investment Horizon: 1-3 years
7. Medium Duration Funds
These funds invest in debt securities with an average maturity of 3-4 years.
Risk Level: Moderate
Suitable for: Investors with medium-term financial goals
Investment Horizon: 3-4 years
8. Long Duration Funds
Long duration funds invest in long-term debt securities with maturities exceeding 7 years.
Risk Level: High (due to interest rate risk)
Suitable for: Investors with long-term goals who can withstand interest rate fluctuations
Investment Horizon: 5+ years
9. Corporate Bond Funds
These funds invest at least 80% of their assets in the highest-rated corporate bonds, focusing on safety and credit quality.
Risk Level: Moderate
Suitable for: Investors seeking relatively safe corporate exposure
Investment Horizon: 3+ years
10. Credit Risk Funds
Credit risk funds invest at least 65% of their assets in corporate bonds that are rated below the highest rating. They aim to generate higher returns by taking on higher credit risk.
Risk Level: High
Suitable for: Risk-taking investors seeking higher yields
Investment Horizon: 3+ years
11. Dynamic Bond Funds
Dynamic bond funds flexibly manage duration based on the interest rate outlook, allowing fund managers to adjust the portfolio as per market conditions.
Risk Level: Moderate to High
Suitable for: Investors who want the fund manager to manage interest rate cycles
Investment Horizon: 3+ years
12. Gilt Funds
Gilt funds invest in government securities of various maturities. Since government securities have no credit risk, these funds are considered the safest in terms of credit quality.
Risk Level: Moderate to High (due to interest rate risk)
Suitable for: Conservative investors concerned about credit risk
Investment Horizon: 3-5+ years
Hybrid Mutual Funds India
Hybrid mutual funds India invest in a mix of equity and debt instruments, offering a balanced approach to investing. These funds aim to provide the growth potential of equities while moderating risk through debt instruments.
1. Conservative Hybrid Funds
These funds invest 10-25% of their assets in equities and the rest in debt instruments. They aim to provide regular income with some capital appreciation.
Risk Level: Low to Moderate
Suitable for: Conservative investors seeking some equity exposure
Investment Horizon: 3+ years
2. Balanced Hybrid Funds
Balanced hybrid funds invest 40-60% of their assets in equity and the rest in debt. They aim to balance growth and stability.
Risk Level: Moderate
Suitable for: Investors seeking moderate growth with lower volatility
Investment Horizon: 3-5 years
3. Aggressive Hybrid Funds (Balanced Advantage/Dynamic Asset Allocation)
These funds invest 65-80% of their assets in equity and the rest in debt. They offer higher growth potential than other hybrid categories.
Risk Level: Moderate to High
Suitable for: Investors with a higher risk appetite
Investment Horizon: 5+ years
4. Multi-Asset Allocation Funds
Multi-asset allocation funds invest in at least three asset classes with a minimum allocation of 10% in each. These typically include equity, debt, and either gold or real estate.
Risk Level: Moderate
Suitable for: Investors seeking diversification across asset classes
Investment Horizon: 3-5 years
5. Arbitrage Funds
Arbitrage funds aim to take advantage of price differences of the same asset across different markets. They primarily use equity arbitrage strategies while maintaining equity taxation benefits.
Risk Level: Low
Suitable for: Investors seeking equity taxation benefits with lower risk
Investment Horizon: 1+ years
Solution-Oriented Funds
Solution-oriented funds are designed to help investors meet specific life goals. They typically come with a lock-in period.
1. Retirement Funds
These funds are designed to help investors build a retirement corpus. They come with a lock-in period until retirement or 5 years, whichever is earlier.
Risk Level: Varies based on the specific fund's strategy
Suitable for: Long-term retirement planning
Investment Horizon: 5+ years or until retirement
2. Children's Funds
Children's funds aim to help parents build a corpus for their children's education or other future needs. They typically have a lock-in period until the child turns 18.
Risk Level: Varies based on the specific fund's strategy
Suitable for: Planning for children's education or other needs
Investment Horizon: Until the child turns 18
Other Types of Mutual Funds
1. Index Funds
Index funds aim to replicate the performance of a specific market index, such as the Nifty 50 or Sensex. They are passively managed funds with lower expense ratios compared to actively managed funds.
Risk Level: Depends on the underlying index
Suitable for: Investors seeking market returns at lower costs
Investment Horizon: 5+ years for equity indices
2. Exchange-Traded Funds (ETFs)
ETFs are similar to index funds but are traded on stock exchanges like individual stocks. They offer the diversification benefits of mutual funds with the trading flexibility of stocks.
Risk Level: Depends on the underlying securities
Suitable for: Investors who want intraday trading capability
Investment Horizon: Varies based on the ETF type
3. Fund of Funds (FoFs)
Fund of Funds invest in other mutual funds rather than directly in securities. They provide additional diversification across fund managers and strategies.
Risk Level: Depends on the underlying funds
Suitable for: Investors seeking broader diversification or specialized strategies Investment Horizon: Varies based on the underlying funds
How to Select Mutual Fund in India
Now that you understand the various types of mutual funds explained above, let's discuss how to select mutual fund in India that aligns with your financial goals and risk profile.
1. Assess Your Investment Goals
Start by clearly defining what you're investing for:
- Short-term goals (1-3 years): Consider liquid funds, ultra-short duration funds, or low-duration funds
- Medium-term goals (3-5 years): Consider balanced hybrid funds, short to medium duration debt funds
- Long-term goals (5+ years): Consider equity funds, aggressive hybrid funds
2. Understand Your Risk Profile
Your risk profile mutual funds suitability depends on:
- Age: Younger investors can typically take more risk
- Income stability: Stable income allows for higher risk-taking
- Financial responsibilities: More dependents may require a more conservative approach
- Risk tolerance: Your psychological comfort with market fluctuations
3. Check Fund Performance
While evaluating mutual fund returns, look at:
- Consistency of performance over different market cycles
- Comparison with the appropriate benchmark index
- Performance relative to peer funds in the same category
- Rolling returns rather than just point-to-point returns
Remember, past performance doesn't guarantee future results, but consistent performance can indicate good fund management.
4. Analyze Fund Attributes
Consider these important factors:
- Expense Ratio: Lower expenses directly impact your returns
- Fund Size: Very large or very small fund sizes might impact performance
- Fund Manager's Experience: Look for experienced managers with good track records
- Fund House Reputation: Established asset management company (AMC) with good processes
- Portfolio Composition: Check if the holdings align with the fund's stated objective
5. Start with a Systematic Investment Plan
For most investors, especially beginners, a Systematic Investment Plan or SIP is an ideal way to invest in mutual funds. It allows you to:
- Invest fixed amounts regularly (monthly, quarterly)
- Average your purchase cost through market cycles (rupee-cost averaging)
- Build disciplined investing habits
- Start with as little as ₹500 per month
Best Mutual Fund for Beginners India
If you're new to mutual fund investing, here are some categories that are considered best mutual fund for beginners India:
1. Index Funds
These passively managed funds track market indices like Nifty 50 or Sensex. They offer:
- Lower costs compared to actively managed funds
- Market-linked returns
- Reduced fund manager risk
- Simplicity in understanding what you own
2. Large-Cap Funds
Large-cap funds invest in established, stable companies, making them:
- Less volatile than mid or small-cap funds
- Easier to understand for beginners
- More resilient during market downturns
3. Balanced Advantage Funds
These dynamically manage equity and debt allocation based on market valuations, providing:
- Automatic rebalancing
- Lower volatility than pure equity funds
- Potential for reasonable returns
4. SIP in Equity Funds Through Index Funds
Starting a SIP in an index fund can be an excellent way for beginners to enter the equity market as it:
- Provides broad market exposure
- Eliminates the need to select individual stocks
- Encourages disciplined investing
5. Debt Funds for Short-Term Goals
For beginners with shorter time horizons, liquid funds or short-duration funds can be appropriate as they offer:
- Lower volatility
- Better returns than savings accounts
- High liquidity
Aligning Mutual Funds with Financial Goals
Different mutual funds serve different financial goals and mutual funds needs:
1. Emergency Fund (0-1 year)
- Suitable funds: Liquid funds, overnight funds
- Why: High liquidity, capital preservation, minimal volatility
2. Short-Term Goals (1-3 years)
- Suitable funds: Ultra-short duration funds, low duration funds, arbitrage funds
- Why: Better returns than savings accounts with controlled risk
3. Medium-Term Goals (3-5 years)
- Suitable funds: Conservative hybrid funds, medium duration debt funds, balanced advantage funds
- Why: Moderate growth potential with manageable volatility
4. Long-Term Goals (5+ years)
- Suitable funds: Equity funds (based on risk tolerance), aggressive hybrid funds
- Why: Higher growth potential, time to ride out market volatility
5. Tax Saving (ELSS)
- Suitable funds: ELSS funds
- Why: Tax deduction under Section 80C with potential for capital appreciation
Common Mistakes to Avoid When Investing in Mutual Funds
When investing in mutual funds, avoid these common pitfalls:
1. Chasing Recent Top Performers
Many investors make the mistake of investing in funds that have recently delivered exceptional returns. This approach of "buying high" often leads to disappointment as funds tend to go through cycles of performance.
2. Ignoring the Expense Ratio
The expense ratio directly impacts your returns. Even a difference of 0.5% can significantly affect long-term returns due to the power of compounding.
3. Over-Diversification
While diversification is important, investing in too many similar funds defeats the purpose and can lead to index-like returns at higher costs.
4. Frequent Switching Between Funds
Constantly moving between funds based on short-term performance can result in higher costs and potentially lower returns. Mutual fund investments require patience.
5. Investing Without Clear Goals
Investing without defining your financial goals and time horizon can lead to selecting inappropriate fund types for your needs.
6. Ignoring Asset Allocation
Your investment should be spread across different asset classes based on your goals, time horizon, and risk tolerance. Focusing solely on returns without considering risk can lead to an imbalanced portfolio.
7. Neglecting Regular Portfolio Review
While frequent switching is not advisable, periodically reviewing your portfolio (once or twice a year) is essential to ensure it remains aligned with your goals.
Taxation of Mutual Funds in India
Understanding the taxation of mutual funds is crucial for effective financial planning:
Equity Funds (>65% equity allocation)
- Short-term Capital Gains (held for less than 12 months): 15% tax on gains
- Long-term Capital Gains (held for more than 12 months): 10% tax on gains exceeding ₹1 lakh per financial year
Debt Funds and Other Non-Equity Funds
As per the 2023 budget changes:
- All debt mutual funds purchased on or after April 1, 2023, will be taxed at the investor's income tax slab rate, regardless of the holding period
- For investments made before April 1, 2023:
- Short-term Capital Gains (held for less than 36 months): Taxed at the investor's income tax slab rate
- Long-term Capital Gains (held for more than 36 months): 20% tax with indexation benefits
Hybrid Funds
Taxation depends on the equity allocation:
- Funds with >65% equity allocation follow equity taxation
- Funds with <65% equity allocation follow debt fund taxation
Conclusion
Understanding the various types of mutual funds in India is the first step toward making informed investment decisions. By aligning fund selection with your financial goals, risk tolerance, and investment horizon, you can create a well-balanced portfolio that helps you achieve your objectives.
Remember that mutual fund investing is a journey, not a destination. Regular monitoring, periodic rebalancing, and staying disciplined during market volatility are key to long-term success.
For beginners, starting with a SIP in index funds or large-cap funds can be an excellent way to begin your mutual fund investment journey. As you gain experience and confidence, you can explore other fund categories to optimize your portfolio further.
The most important aspect of mutual fund investing is to stay focused on your financial goals rather than getting swayed by short-term market movements or the latest investment fads. With patience, discipline, and a well-thought-out strategy, mutual funds can serve as powerful vehicles to help you achieve financial freedom.
Whether you're saving for retirement, planning for your child's education, or building wealth for the future, there's a mutual fund type suited to your needs. The key is to choose wisely and invest consistently.
FAQs About Mutual Fund Types in India
1. What is the minimum amount required to start investing in mutual funds?
You can start investing in most mutual funds with as little as ₹500 through SIP. For lump sum investments, the minimum amount typically ranges from ₹1,000 to ₹5,000, depending on the fund.
2. How do I know which mutual fund type is right for me?
The right mutual fund type depends on your financial goals, investment horizon, and risk tolerance. Consider consulting a financial advisor for personalized guidance.
3. Are mutual funds safer than direct stock investments?
Mutual funds, especially diversified ones, generally carry lower risk than individual stocks due to their diversification across multiple securities. However, all investments carry some level of risk.
4. Can I withdraw my mutual fund investments anytime?
Most open-ended mutual funds allow redemption anytime (except for ELSS funds with a 3-year lock-in period). However, some funds may charge an exit load if redeemed before a specified period.
5. How are mutual fund returns taxed in India?
Taxation depends on the fund type (equity, debt, or hybrid) and holding period. Equity funds are taxed at 15% for short-term gains and 10% for long-term gains above ₹1 lakh. Debt funds purchased after April 1, 2023, are taxed at your income tax slab rate regardless of holding period.
6. What is the difference between growth and dividend options in mutual funds?
In the growth option, returns are reinvested, increasing the NAV, while in the dividend option, returns are distributed periodically. Growth options are generally more tax-efficient for long-term investors.
7. How often should I review my mutual fund portfolio?
A semi-annual or annual review is sufficient for most investors. However, major life events or significant market changes might warrant an additional review.
