Most novice investors have a collective illusion that mutual funds invest only in stocks. Mutual funds are broadly classified into three categories – equity funds, debt funds, and hybrid funds. We have covered the following in this article:
1. Do Mutual Funds Invest Only in Stocks?
No, mutual funds don’t invest only in stocks. This wrong perception is mostly because the mutual fund companies, in their advertisements, conclude saying ‘mutual funds are subject to market risks’. One should understand that market risks mean the chances of prices of securities fluctuating. If the fluctuation happens towards the south at a time when you wish to withdraw funds, then you may suffer losses. This is market risk in brief. However, mutual funds invest across equity and debt instruments, depending on their type. Also, some portion of the pooled investments would be kept in cash or invested in cash equivalents in order to facilitate liquidity and redemption requests.
2. Types of Mutual Funds
Mutual funds are broadly classified into three types – equity mutual funds, debt mutual funds, and hybrid/balanced mutual funds. Equity funds are those mutual funds that invest predominantly (at least 65%) in equity shares of companies across all market capitalisations. Equity funds are further divided based on the market capitalisation of the companies that they go onto invest. Also, there is a tax-saver fund available. Equity-linked savings scheme (ELSS) is the only kind of mutual funds covered under Section 80C of the Income Tax Act, 1961.
Equity funds are also classified based on the sector and theme of the companies that they choose to invest in. Equity funds that track a popular stock market index are called index funds. Equity funds are considered to be the riskiest among all mutual funds as they are exposed to the equity market. Also, they have the potential to offer the highest returns among all mutual funds.
Debt mutual funds are those mutual funds that invest predominantly (at least 65%) in debt instruments such as treasury bills, government bonds, high-rated corporate bonds, and so on. Debt funds are considered to be as the least risky among all mutual funds. If you are not willing to bear any risk, then investing in debt funds is apt for you. Hybrid or balanced mutual funds invest across both debt and equity instruments to balance the risk-reward ratio.
Investors must note that the fund managers cannot invest in those instruments that are not in line with the investment objective of the fund. For instance, a debt fund manager cannot pick up risky equity shares, which is against the investment mandate of the mutual fund plan. Also, there are regulatory bodies such as the Securities and Exchange Board of India (SEBI) and the Association of Mutual Funds in India (AMFI) to ensure that the fund houses are ethical in their operations.
3. What Should Investors Do?
With a wide range of mutual funds available, investors must assess their requirements, risk profile, and investment horizon before they choose to invest in any mutual fund. This is very important as investing in a wrong mutual fund may lead to financial difficulties when the funds are needed. If an individual is not able to figure which fund suits them the best, then they can seek the help of a financial advisor.
Mutual funds don’t invest only in stocks. As mentioned above, they also invest in debt securities. There are mutual funds that suit different requirements, risk level, and investment horizon. Therefore, investors must know what they are looking for before investing in any mutual fund scheme. If an investor is finding it hard to identify the right mutual fund for them, then they should consult a financial advisor.