Mutual Funds are Financial Instruments that were created to help the Small Investor enter the Financial Markets and have a Diversified Portfolio. Mutual Funds are operated by Asset Management Companies (AMC).
Mutual Funds pool together money from several small investors and invest them in Stocks / Debt Instruments depending on the weather the Fund is an Equity Fund or a Debt Fund. The AMC appoints a Fund Manager to make the required analyses before investing and to manage the investment.
Since the Fund Manager is an experienced Investment Professional, the return on investment are usually higher than what could be generated by Retail Investors if they invested individually. Also, since the Mutual Funds pool in money from large number of users, they are able to invest a great amount of money and hence able to achieve greater diversification.
There are different types of Mutual Funds based on the characteristics by which they are classified.
- Based on the Market where the Fund plans to Invest
Depending on the type of market the Mutual Fun Plans to invest in they are classified into
Equity Funds
Debt Funds
Money Market Funds
Equity Funds
Equity Funds invest their funds in the Stock Market buy buying shares of companies. Depending upon their appetite for Risk, they could be further classified into
Blue Chip Funds - Invest Primary in well established Companies (Blue Chip Stocks). Companies with Large Market Capitalization (Large Caps)
Emerging Blue Chip Funds - Invest in upcoming companies that could turn out to be Blue Chips in the near future. Primarily Small Cap and Mid Cap Companies
Debt Funds
Debt Funds invest in the Debt Market buy buying Bonds from Government Bodies or Corporations. The Bonds that are let out buy Governments / Municipalities / Provinces are considered less risky than the bonds let out by Corporations.
The bonds have a coupon rate (interest rate) at which they provide returns. The interest is usually given out every quarter or every six months. The income that comes in from the bonds as interest is what will be provided as return on investment to the investors who provided their money to be pooled into the Mutual Fund.
Debt Funds generally invest in Bonds that have a maturity period greater than 1 Year.
Money Market Funds
Money Market Funds invest in those debt instruments that have Maturity Period less than 1 Year. They are mostly Short Term Debt instruments that are issue by the Local Government, Federal Government, Municipalities, Big Corporations.
Since they have a Maturity Period anywhere between 90 days and an Year, the Risk of losing the investment money is very low. Money Market Funds are considered to have the least Risk in theory. In practicality Money Market Funds are considered to have ZERO RISK of losing your investment capital.
Based on the Type of Return to Investor
When considered the method by which the Mutual Fund provides returns to the investor, they could be broadly classified intoGrowth Funds
Dividend Funds
The returns for investor in Growth Funds is got by the increase value of NAV (Net Asset Value). On sale of the units of the Mutual Fund, the investor would get more money that what he / she had paid for when they purchased the same unit.
On the other hand, Dividend Funds pay out a small portion of the profits every month on a specified date. Dividend Funds provide the option of getting monthly returns without having to actually sell any Mutual Fund Units.
It is for this reason that the NAV of a Growth Option of a Mutual is always higher NAV than the NAV of the Dividend Option.