Personal finance: Know the different kinds of mutual funds

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Last week, we discussed why parking some money in mutual funds isn’t a bad option, provided you have a basic understanding of what your investment objectives are: are you looking to save for retirement, or repay a student loan? What is your tolerance for risk, and how many more years do you have left to work? Here’s a look at some of the types of mutual funds that exist.

Tax saving funds

While planning your retirement savings, you must not ignore the taxation aspect. There are specific kinds of mutual funds called equity linked savings schemes (ELSS) that as Archit Gupta, founder and CEO, ClearTax, an online e-filing portal put it, “Offers the dual benefit of tax deductions and wealth creation over time.” The money in these funds is used to primarily invest in the equity market that avail returns in the range of 10-12 per cent, which is twice the interest offered by tax-saving fixed deposits. But be warned, these investments come with a lock-in period of three years.

Open-ended funds

These types of funds allow you to stay invested for any choice of tenure without warranting any upper or limits of investments. This means that you can buy or redeem any number of these mutual fund units throughout the year with subscriptions and redemptions being allowed on the prevailing net asset value. Suresh Sadagopan, founder, Ladder7 Financial Advisories, a professional financial planning and wealth advisory firm says, “Open-ended MFs are the most common kind of MF schemes available. It is suitable for all kinds of investors as it offers liquidity at every point. One may look at close-ended funds only if one has that kind of tenure to invest and only if it allows some specific benefit.” Investors prefer putting money in open-end funds owing to the ease of investments at low cost.

Equity funds

These mutual funds are best suited for investors inclined to benefit from the highs and lows of the equity stock (shares) market. Apart from earning returns and benefit from regular dividends on equity funds instruments, investors are saved from the risk of losing the entire investment amount as long as you retain a long-term investment outlook. The risk is typically based on the industry, for instance, the IT sector seems to be stable than say, the oil industry, at present. However, this is not a fixed state of affairs. So you need to understand the composition of your mutual fund, and look out for risk-o-meters that indicate the risk factor involved in that particular mutual fund investment that you are looking at.

Sahil Arora, director and head of Investments, Paisabazaar.com, a virtual debt syndication service said, “While equities can be highly volatile in the short term, it beats inflation and other asset classes like fixed-income instruments by a wide margin over the long run. Another benefit of investing in equity mutual funds is that they are well diversified across stocks and sectors, which helps to reduce risk and usually they are liquid and come with no lock-in period.”

Mutual funds give better returns over a period than the average inflation rate, and though the pandemic makes it difficult for us to predict the inflation rate the way that we may have been able to in the previous years, the market itself is resilient, backed by industries. Thus, it is highly probable that the returns will continue to stay higher than inflation rates.

Debt funds

If you are wary of risky investments or prefer options that promise fixed returns and guarantee capital protection, debt funds will serve your purpose. This is because debt funds are investments in government bonds and securities, corporate bonds or other fixed income instruments. So the initial capital that you invest does not waver, what will vary is the returns on your investment, which is mostly lower than the returns that you get from equity mutual funds. Depending on the holding period, the returns from debt funds can be long-term or short-term gains. Short-term funds typically have a short maturity period (holding period; tenure over which the investors stay invested in a mutual fund) of usually three years or less. If you remain invested in these funds for at least three years, you get the benefit of long-term capital gains tax. If you redeem your investment within three years, the capital gains will be added to your income and will be taxed as per your income tax slab rate.

Pension funds

These kinds of mutual funds instruments suit best if you are looking for a regular and constant income source. Designed for investors with a long-term perspective on income and returns, pension funds start generating steady returns by the time you reach your retirement age. Besides Raj Khosla, founder and managing director, MyMoneyMantra, a financial services marketplace says, “The investment in equity with debt helps to steadily grow the retirement corpus while ensuring maximum capital protection. With exposure to diverse asset classes, pension funds aim to obtain a higher yield as compared to fixed return schemes, and thus try to ensure that returns beat the inflation rate.” You may choose between receiving returns in a lump sum, pension, or both.