Types of Mutual Funds: Categories and Sub-Categories, Who should invest in which Mutual Fund and Taxation

Mutual funds have become a cornerstone of modern investing, allowing individuals to grow their wealth without picking individual stocks or bonds. By pooling money from multiple investors, mutual funds enable access to professionally managed, diversified portfolios tailored to various financial goals.

Whether you’re a young professional aiming for long-term growth, a parent saving for a child’s education, or a retiree seeking a steady income, there’s a mutual fund for you.

This article dives deep into the types of mutual funds, their categories and sub-categories, who they suit best, how they’re taxed, and everything you need to know to make informed investment choices.

Understanding Mutual Funds

A mutual fund is a collective investment vehicle formed when an asset management company (AMC) pools money from several individual and institutional investors to purchase securities such as stocks, debentures, and other financial assets.

The AMCs have professional fund managers to manage the pooled investment. Fund units are assigned to Mutual fund investors corresponding to their quantum of investment. Investors can purchase or redeem fund units only at the prevailing net asset value (NAV).

Authorities like the Securities and Exchange Board of India (SEBI) regulate mutual funds, ensuring transparency and investor protection.

The beauty of mutual funds lies in their variety. They cater to different risk levels, investment horizons, and financial objectives. Broadly, they’re classified by asset class (equity, debt, hybrid), investment objective (growth, ICDW), and structure (open-ended, closed-ended).

Categories and their Sub-Categories of Mutual Funds

Mutual funds come in several flavours, each designed for specific investor needs. Below is a comprehensive breakdown.

Equity Mutual Funds

Equity mutual funds invest primarily in stocks, making them ideal for those seeking long-term capital growth. They’re riskier due to market fluctuations but offer higher return potential over time.

Large-Cap Funds:

These funds are invested in large, established companies with a proven track record, such as blue-chip firms like Reliance Industries, HDFC, etc. They’re less volatile than smaller stocks, making them a safer bet within the equity category. These funds must invest at least 80% of their assets in equity and equity-related instruments of large-cap companies.

Mid-Cap Funds:

According to market capitalisation, these funds buy stocks of top companies between 101 and 250. They target medium-sized companies and offer a balance of growth and risk with a minimum of 65% of their assets in equity in mid-cap companies. They invest in firms that have outgrown their small-cap phase but aren’t yet giants and expect higher volatility and higher potential returns.

Small-Cap Funds:

These focus on smaller companies between 101 and 250 according to market capitalisation with significant growth potential. They’re the riskiest equity funds due to their sensitivity to market swings but can deliver outsized gains during bull markets. Mid-cap funds must invest at least 65% of their assets in equity and equity-related instruments of mid-cap companies.

Multi-Cap Funds:

Multi-cap funds have no restriction on multi-cap funds to follow an investment strategy which is confined to specific market capitalisation. At least 65% of their assets in equities and equity-related instruments take a diversified approach, spreading investments across large, mid, and small-cap stocks, offering a mix of stability and growth.

Sectoral/Thematic Funds:

These concentrate on specific industries like technology, banking, and defence, as well as themes like sustainability. They’re high-risk because their performance hinges on one sector’s success and is focused on one industry within different diversification of companies.

Dividend Yield Funds:

They invest in companies that pay dividends comparatively frequently, which is why they are called dividend yield funds. These funds target companies that consistently pay high dividends, appealing to investors who want income alongside growth. These funds can also diversify their portfolio since they must invest at least 65% of their corpus into equity and equity-related instruments. In comparison, 35% gives them space for different financial instruments. 

Value Funds:

Value funds invested in undervalued stocks in the market have been overlooked. These funds aim for long-term appreciation as their worth is recognised over time.

Growth Funds:

These invest in fast-growing companies, even if their stock prices seem high, betting on future earnings to justify the cost.

Equity-Linked Savings Scheme (ELSS):

Popular in India, ELSS funds offer tax benefits under Section 80C with a 3-year lock-in, blending equity growth with tax savings.

Debt Mutual Funds

Debt funds invest in fixed-income securities like bonds, treasury bills, and money market instruments. They’re less risky than equity funds and suit investors prioritising safety and steady income.

Liquid Funds:

These invest in ultra-short-term instruments (maturity up to 91 days), offering high liquidity and minimal risk—perfect for parking surplus cash.

Ultra-Short Duration Funds:

With 3–6 months maturities, these funds provide slightly higher returns than liquid funds while keeping risk low.

Low Duration Funds:

Low-duration funds invest in financial instruments in debt. Maturing in 6–12 months, they balance returns and interest rate risk.

Short Duration Funds:

Short-duration funds are invested in financial instruments in debt. These have a 1–3 year horizon, offering moderate returns with manageable ris3-year

Medium Duration Funds:

Medium-duration funds invest in financial instruments in debt. With 3–4-year maturities, they’re sensitive to interest rate changes but offer higher yields.

Long Duration Funds:

Long-duration funds invest in financial instruments in debt. Targeting securities with over 7 years to maturity, these suit long-term investors who are comfortable with interest rate fluctuations.

Dynamic Bond Funds:

These adjust their portfolio duration based on interest rate trends, aiming to optimise returns.

Corporate Bond Funds:

Investing in high-rated corporate bonds offers better yields than government securities with moderate risk.

Gilt Funds:

These focus on government bonds, virtually eliminating credit risk but exposing investors to interest rate movements.

Hybrid Mutual Funds

Hybrid funds combine equity and debt, balancing risk and reward based on the investor’s preference.

Aggressive Hybrid Funds:

Aggressive funds invests 65–80% equity and 20–35% debt, these lean toward growth with moderate stability.

Conservative Hybrid Funds:

conservative funds works on allocating 10–25% to equity and 75–90% to debt, they prioritise safety with a touch of growth.

Balanced Hybrid Funds:

the name itself says that the balanced funds are balanced they offer a middle ground by splitting 40–60% between equity and debt.

Dynamic Asset Allocation Funds:

These dynamic funds shifts between equity and debt are based on market conditions and adaptation to volatility.

Multi-Asset Allocation Funds:

Beyond equity and debt, they include assets like gold or real estate for broader diversification.

Arbitrage Funds:

These exploit price differences in equity markets (e.g., cash vs. futures), delivering low-risk, tax-efficient returns.

Solution-Oriented Funds

These funds are designed for specific life goals and have lock-in periods to encourage disciplined investing.

Retirement Funds:

These build a corpus for post-retirement life, often with a 5-year lock-in, blending equity and debt.

Children’s Funds:

Aimed at goals like education or marriage, they mix growth and safety with a lock-in period.

Other Funds

Index Funds:

These index funds passively track indices, like the Sensex or Nifty 50, and offer low-cost exposure to the market.

Fund of Funds (FoF):

These funds of funds invest in other top-performing mutual funds, providing instant diversification.

International Funds:

These tap into global markets such as the U.S. and Europe, diversifying beyond domestic risks.

Who should invest in Equity Mutual Funds?

Equity mutual funds are ideal for investors with a higher risk tolerance seeking long-term capital growth. These funds invest primarily in stocks and are suitable for those with a five to seven years or more time horizon.

Considerations:

• Risk Tolerance: Equity funds are subject to market volatility. Investors should be comfortable with short-term fluctuations in their investment value.
• Investment Horizon: A longer time frame (5+ years) can help mitigate the risks associated with stock market investments.
• Financial Goals: Ideal for goals like retirement, buying a house, or funding children's education, where substantial growth is desired over the long term.

Equity mutual funds have historically delivered higher returns over the long term than other investment types, making them a popular choice for wealth creation.

Who should invest in Debt Mutual Funds?

Debt mutual funds suit conservative investors looking for regular income with lower risk. These funds invest in fixed-income securities like bonds, debentures, and treasury bills.

Considerations:

• Risk Tolerance: These funds are conservative investors who do not want to experience stock market volatility. Still, debt funds carry interest rate, credit, and inflation risks.
• Investment Horizon: Ideal for short to medium-term goals (1-3 years), such as buying a car or creating an emergency fund.
• Liquidity Needs: Debt funds offer better liquidity than fixed deposits, making them suitable for investors who need periodic withdrawals.

Debt mutual funds often provide better returns than traditional fixed-income instruments like fixed deposits, especially for investors in higher tax brackets.

Who should invest in Hybrid Mutual Funds?

Hybrid mutual funds are designed for investors who want a balanced approach to growth and income. These funds invest in a mix of equity and debt instruments.

Considerations:

• Risk Tolerance: Suitable for moderate risk-takers. The equity component provides growth potential, while the debt component offers stability.
• Investment Horizon: Suitable for medium to long-term goals (3-5 years).
• Diversification: Provides diversification across asset classes, reducing overall portfolio risk.

Hybrid funds offer the best of both worlds, making them an attractive option for investors who want to benefit from equity growth while having the safety net of debt investments.

Who should invest in Solution-oriented Mutual Funds?

Solution-oriented mutual funds, such as retirement and child education schemes, are tailored to specific financial goals. These funds typically have a long-term investment horizon and come with a lock-in period.

Considerations:

• Goal-based Investing: Ideal for investors with specific long-term goals like retirement or a child’s education.
• Risk Tolerance: The risk level varies based on the fund’s asset allocation. Typically, these funds shift from aggressive to conservative as the target date approaches.
• Lock-in Period: Be prepared for a lock-in period, which ensures disciplined investing towards the goal.

These funds often come with tax benefits, providing a tax deduction of Rs.1.5 lakh under section 80(c), making them an attractive option for long-term financial planning.

Who should invest in Index Funds?

Index funds suit investors looking for a low-cost, passive investment strategy. These funds track a specific market index, like the Nifty or Sensex, and aim to replicate its performance.

Considerations:

• Risk Tolerance: Suitable for investors comfortable with market risks but looking for lower management fees and stable performance.
• Investment Horizon: This is best for long-term investors (5+ years) who believe in the overall market's growth potential.
• Cost Efficiency: Lower expense ratios than actively managed funds make them cost-effective.

Over the long term, many actively managed funds struggle to outperform their benchmark indices.

Points to Consider Before Investing

When deciding which mutual funds to invest in, consider the following factors:

Risk Appetite: Assess your comfort level with risk and choose funds that match your risk tolerance.

Investment Goals: Align your fund selection with your financial goals and investment horizon.

Diversification: Spread your investments across different fund categories to reduce risk.

Expense Ratios: Consider the cost of investing in mutual funds, as higher fees can erode returns over time.

Past Performance: While not indicative of future results, analysing a fund’s historical performance can provide insights into its potential.

Investing in mutual funds can be a powerful tool for achieving financial goals. By understanding the different categories and their unique characteristics, you can make informed decisions that align with your needs and objectives.

Who Should Invest in Which Mutual Fund?

Choosing the right mutual fund hinges on your financial goals, risk tolerance, and investment timeline. Here’s a detailed guide:

Young Investors (18s–30s)

Risk Tolerance: High.

Best Funds: Large-cap, mid-cap, small-cap, multi-cap, ELSS, aggressive hybrid funds.

Why: With decades ahead, young investors can weather market dips and leverage compounding to create wealth. ELSS also offers tax breaks.

Example: A 20-year-old tech professional might invest in a small-cap fund for high growth, accepting short-term volatility.

Middle-Aged Investors (30s–50s)

Risk Tolerance: Moderate to high.

Best Funds: Multi-cap, balanced hybrid, dynamic asset allocation funds.

Why: Balancing growth with stability is key as responsibilities like mortgages or kids’ education emerge.

Example: A 40-year-old manager might choose a multi-cap fund to diversify across market segments.

Pre-Retirees (50s–60s)

Risk Tolerance: Moderate to low.

Best Funds: Debt funds (short duration, corporate bond), conservative hybrid funds, retirement funds.

Why: The focus shifts to preserving capital while earning steady returns.

Example: A 55-year-old nearing retirement might opt for a short-duration debt fund for safety.

Retirees (60s and above)

Risk Tolerance: Low.

Best Funds: Liquid funds, gilt funds, conservative hybrid funds.

Why: Liquidity and regular income take priority over growth.

Example: A 65-year-old retiree might use liquid funds for emergency cash and gilt funds for stability.

Goal-Based Investors

Short-Term (1–3 Years): Liquid, ultra-short duration funds, low risk and easy access.

Medium-Term (3–5 Years): Short-duration debt funds, balanced hybrid funds with moderate growth and safety.

Long-Term (5+ Years): Equity funds, ELSS, retirement funds which maximising growth.

Tax-Saving Investors

Best Funds: ELSS.

Why: Offers tax deductions up to ₹1,50,000 under Section 80C with 80% equity exposure.

Risk-Averse Investors

Low-Risk Funds: Liquid funds, gilt funds, arbitrage funds.

Why: Safety and predictable returns outweigh the need for high growth.

Taxation of Mutual Funds

Taxation in mutual funds is the same for all types of slabs that differ from holding periods. Below is a detailed look based on Indian tax laws as of March 2025

Equity Mutual Funds

• Short-Term Capital Gains (STCG): Sold within 12 months taxed at 20%.
• Long-Term Capital Gains (LTCG): Held over 12 months, taxed 12.5%.
• Dividends: Taxed at the investor’s slab rate.

Debt Mutual Funds

STCG: Sold within 12 months taxed at the 20%

LTCG: Held over 12 months—taxed at 12.5%.

Dividends: Taxed at the investor’s slab rate.

Hybrid Funds

STCG: Sold within 12 months taxed at the 20%

LTCG: Held over 12 months—taxed at 12.5%.

Dividends: Taxed at the investor’s slab rate.

Systematic Investment Plans (SIPs)

Each SIP instalment is a separate investment. If sold:

• Within 12 months, STCG rules apply.
• Beyond that, LTCG rules apply.

Tax-Saving Tips

ELSS: investments made in ELSS on a financial year can claim deductions of up to 1,50,000 under Section 80C.

Loss Set-Off: Offset capital losses against gains

For example, selling a loss-making fund to reduce tax on a profit made in a financial year.

Why Mutual Funds Matter

They democratise investing, allowing small investors to access diversified portfolios once reserved for the wealthy. Professional management, liquidity, and regulatory oversight make them a trusted choice.

Example 1: Ravi, a 28-year-old software engineer, invests ₹100 monthly in a small-cap fund via SIP. Over 10 years, assuming a 12% annualised return, his ₹12,000 investment grows to ₹23,233, a 90% gain on overall investment, showcasing equity’s power for youth.

EXAMPLE 2: Meena, 62, shifts her savings to a liquid fund yielding 6% annually. Her ₹5,00,000 investment earns ₹30,000 yearly, providing steady income without stock market stress.

Conclusion

Mutual funds are versatile tools for wealth creation, offering options for every investor. They include aggressive equity funds for risk-takers, stable debt funds for the cautious, and hybrid funds for those in between. Matching the right fund to your risk profile, goals, and timeline is key. Taxation, while complex, can be navigated with planning, especially with tax-saving options like ELSS. Start small, stay disciplined, and consult a financial advisor to build a portfolio that works for you.