When it comes to mutual funds, investors have a variety of options to choose from, including equity, debt, and hybrid mutual funds. Each type of mutual fund is designed to serve different investment goals and cater to various risk appetites, making it essential for investors to understand the distinctions between these options. Broadly there are three main types of mutual funds: 1) Equity, 2) Debt,and 3) Hybrid.
Equity Funds
Equity mutual funds primarily invest in the stocks of various companies. These funds can be further divided into subcategories based on the market capitalisation of the companies included in the fund's portfolio. Examples include large-cap funds, small-cap funds, mid-cap funds, and multi-cap funds. These funds tend to be more volatile and carry a higher risk because of their reliance on the stock market, making them suitable for aggressive investors with a higher risk appetite.
Debt Funds
Debt mutual funds focus on investing in a range of debt securities and money market instruments, such as commercial papers, debentures, certificates of deposits, treasury bills, and government securities. Like equity funds, debt funds can be further divided into subcategories, including overnight funds, ultra-short term funds, short-term funds, and long-term funds. These funds offer more stability and lower risk compared to equity funds, making them an ideal choice for conservative investors who prioritise capital preservation.
Hybrid Funds
Hybrid mutual funds, on the other hand, combine investments in both equity and debt markets. By diversifying across these asset classes, hybrid funds aim to balance risk and returns for investors. The allocation between equity and debt can vary based on the specific fund's strategy, the fund manager's decisions, and the fund's goals. Hybrid funds are a good choice for moderate investors willing to take on a slightly higher level of risk for the potential of greater returns.
Choosing the Right Fund
Selecting the appropriate type of mutual fund depends on your risk tolerance and investment horizon. Aggressive investors with a higher risk appetite may find equity funds most suitable, while conservative investors seeking stability may prefer debt funds. For those in search of a middle ground, hybrid funds can offer a balance between risk and return.
Sreeram Ramdas, vice-president at Green Portfolio, told ABP Live that Hybrid would be the prudent option for an average investor. "The earnings multiple of equity indices seem to be stretched. The price to earnings of smallcaps which is around 31x are well above average," he clarified.
However Ramdas said if an investor has the tenacity to selectively pick stocks, they should be going heavy on equities. "Even at these times, we have stocks in our portfolio that are severely undervalued all the while having strong fundamentals," he added.
These 3 funds each have their own unique features and risk profiles. What are they:
Equity Funds: These funds allocate investments in company stocks. The returns investors receive are directly tied to market performance, making these funds highly volatile and risky.
Debt Funds: These funds focus on investing in debt securities and money market instruments. Investors benefit from more stable returns, as these funds are less influenced by market fluctuations. They generally carry lower risk.
Hybrid Funds: These funds combine investments in both equity and debt instruments, offering a balance of risk and return. Returns are partially stable and partially reliant on market performance, resulting in a moderate level of risk for investors.
Vinayak Magotra, Head of Investment product at Centricity Wealthtech, explained on how to choose between equity and debt funds. According to him, it is not binary but depends on three important factors: 1) The risk profile of the investor, 2) The short-, medium-, and long-term financial goals one has set for oneself, 3) The age profile of the investor.
"These 3 factors determine a suitable asset allocation for the investor which will constitute both debt and equity funds. Hybrid funds aim to combine equity and debt asset classes therefore performing broad asset allocation for the investor within the scheme itself. 'Asset allocation' and 'goal planning' being the key elements in any investment decision," he opined.
At the end, one thing you need to remember is that each type of mutual fund serves distinct investment objectives and risk profiles. It's crucial for investors to evaluate their financial goals and risk tolerance before choosing the mutual fund that aligns with their investment strategy. By doing so, investors can make more informed decisions and work towards achieving their long-term financial objectives.
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