When you walk into a bike showroom, you will see a wide variety of bikes. There are Glamours, Bullets, and possibly even sports bikes such as the KTM and R15. Each bike in the showroom has a variety of different functions. A sports bike may be preferred by a youthful person, whereas a Glamour or Bullet may be preferred by a married person with a spouse or kids. Similarly, mutual funds in India come in a variety of forms. 

Did you know? 

There are two other ways to categorize different types of mutual funds: 

• Based on the underlying assets (equity, debt, gold, hybrid). 

• Based on the length of time till they reach maturity (open-ended and closed-ended funds). 

Each fund type is designed to help investors achieve a particular set of goals. Some of the most popular types of mutual funds available in India are listed below: 

Types of funds based on asset class: 

• Debt funds: The funds that invest in securities that generate fixed income like Treasury Bills, Corporate Bond, Commercial papers, Government Securities, and many other market instruments are called Debt Funds. All these market instruments have a pre-planned maturity date and rate of interest that the buyer can obtain on maturity and, therefore, it is also known as Fixed-Income Securities. As a result, debt securities are considered a low-risk investment choice. 

• Equity funds: As the name recommends, equity funds invest in the shares of different kinds of companies across sectors. The fund manager, who is managing your investment, always tries to offer great returns to you by spreading your investment across companies from different sectors or with various market capitalization. Generally, Equity Funds are known to offer better returns than term deposits or debt-based funds. There is a large amount of risk involved with these funds since their performance depends on various market conditions. But there is a good choice if you wish to invest for long-term goals such as retirement planning or purchasing a house because the level of risk comes down over time. 

• Hybrid funds: Have you ever wondered, what if you can have both an Equity fund and a Debt fund in your one investment? If your answer is ‘NO’, then we would like to introduce to you another type of Mutual Funds known as Hybrid Mutual Funds or Hybrid Funds. Hybrid Funds are those funds that invest in a mix of both Equity and Fixed-income (Debt) securities. Based upon the asset allocation between Equity and Debt. 

Hybrid funds are further defined into various sub-categories. 

• Open-ended mutual funds: It is secure to say that when people say mutual funds, they only mean Open-Ended mutual funds. Far from their Closed-Ended counterparts, the units of open-ended funds are not traded on any stock exchanges, be it BSE or NSE. Further, there is no limitation on the number of fund units that the fund can issue at once. Investors can purchase or redeem fund units from the fund house or asset management company on any business day at the current Net Asset Value or NAV of the scheme. The NAV is determined by the performance of underlying securities of that fund.No maturity period exists in this scheme. 
• Close-ended mutual funds: Close-ended funds come with a pre-planned maturity period. Investors can invest in the fund only when it is launched. They can withdraw or take out their money from the fund only at the time of maturity. These funds are listed similarly to the shares in the stock market. In case investors want to redeem their positions, they can sell the units in the Exchange where the funds are listed. However, this fund is not much liquid because the trade volume is lesser in this fund. 

Types of funds based on investment objective: 

Mutual funds are often referred to as quick and easy investment goals. 

• Growth funds: Capital appreciation is one of the main objectives of Growth funds. These funds keep a remarkable segment of the money in stocks. These funds can be comparatively riskier due to high equity exposure, and therefore, it is better to invest in them for the long-term period. But if you are close to your goal, for example, you may want to avoid these funds. 

• Income funds: As the name suggests, income funds try to grant investors a constant level of income. These are debt funds that invest the maximum in bonds, government securities, and deposit certificates, etc. They are affordable for different-term goals and investors with a lower risk appetite. 

• Liquid funds: It puts your money in short-term money market instruments like treasury bills, Certificate of Deposits (CDs), term deposits, commercial papers, and so on. Liquid funds help to safely park your surplus money for a few days to a few months or make an emergency fund. 

• Tax saving funds: It provides you with tax benefits under Section 80C of the Income Tax Act. When you invest in these funds, you can claim deductions to Rs 1.5 lakh each year. An example of Tax Saving Funds is ELSS (Equity Linked Saving Scheme). 

Read Next: Why Should You Invest in Mutual Funds?

For more information, reach us at support@prudentwealth.in

Team, MyGoalMySip.

1. Money Market & Liquid Funds: 

Retail investors’ primary investment option for storing excess cash has been savings bank accounts. Most investors consider these to be their only options, while others believe that storing excess funds elsewhere will erode their value and give no liquidity.

A new study highlights a more appealing option: Liquid Fund / Money Market Mutual Funds. The research shows that surplus cash placed in money market mutual funds earns excellent post-tax returns while maintaining an acceptable level of principal safety and liquidity.

Liquid Funds invest primarily in extremely liquid money market instruments and short-term debt securities, providing high liquidity. To achieve optimal returns while ensuring safety and liquidity, they invest in very short-term products such as Treasury Bills (T-bills), Commercial Paper (CP), Certificates of Deposit (CD), and Collateralized Lending & Borrowing Obligations (CBLO) with residual maturities of up to 91 days.

These funds process redemption requests in one working day (T+1).

2. Income Funds: 

They invest primarily in debt instruments of various maturities that are consistent with the funds’ objectives, with any residual funds being invested in short-term products such as Money Market instruments. These funds often invest in products that have a medium to long-term maturity.

3. Short-Term Funds: 

Short-term debt funds invest in debt instruments with a shorter maturity or length than long-term debt funds. Debt and money market instruments, as well as government securities, make up the majority of these. These funds have a longer investment horizon than liquid funds but are shorter than medium-term income funds.

4. Floating Rate Funds (FRF): 

FRFs are a type of income fund that invests in fixed income debt products such as bonds, debentures, and government securities, whereas income funds invest in fixed income debt instruments such as bonds, debentures, and government securities. FRFs generally invest in products with floating interest rates.

The Mumbai Inter-Bank Offer Rate (MIBOR), which is the benchmark rate for debt instruments, is usually tied to floating-rate securities. The interest rate is reset regularly based on the movement of the interest rate. The goal of FRFs is to provide investors with consistent returns that are consistent with market interest rates.

5. Gilt Funds: 

The term ‘gilt’ refers to government-issued securities. A gilt fund invests in government securities issued by the federal and state governments over a variety of periods. Because the government is the issuer of the securities, these funds are generally risk-free. Gilt funds invest in Gilts that are either short-term or long-term in maturity. Depending on their maturity profile, gilt funds carry a significant level of interest rate risk.

The larger the interest rate risk, the longer the maturity profiles of the instruments are. (Interest rate risk refers to the influence of rising and falling interest rates on the market price of debt instruments. When interest rates fall, market prices of debt instruments rise, and vice versa.)

6. Interval Funds: 

The features of open-ended and closed-ended mutual funds are combined in an interval fund, which is open for subscription and redemption only during specified transaction periods (STPs) at pre-determined intervals. In other words, Interval funds only accept Unit redemptions during STPs.

As a result, between two STPs, are similar to closed-ended schemes and must be registered on stock exchanges. Interval funds, unlike traditional closed-ended funds, do not have a maturity date and are thus open-ended.

As a result, one can keep their money in an Interval Fund for as long as they want to like open-ended schemes. Interval funds are thus similar to Fixed Maturity Plans (FMPs) with roll-over capability in that they allow investments to be rolled over from one period to the next.

Interval funds are primarily debt-oriented investments, but they can also invest in equities if the scheme’s investment objective and asset allocation are indicated in the Scheme Information Document.

Depending on whether the underlying portfolio is mostly invested in stocks or debt securities, interval funds are taxed similarly to other mutual funds. The fund is taxed as a non-equity fund if it invests 65 percent or more of its assets in debt instruments.

7. Multiple Yield Funds: 

Multiple yield funds (MYFs) are debt-oriented hybrid funds that invest primarily in debt instruments, and to a lesser extent, in dividend-paying stocks.

Debt instruments can generate profits with less risk, while equities help with long-term capital appreciation. MYFs primarily invest in short-to-medium-term debt and money market securities with short-to-medium-term residual maturities.

8. Dynamic Bond Funds: 

DBFs invest in a variety of debt securities with varying maturity characteristics. These funds are actively managed, and the portfolio changes dynamically depending on the fund managers’ interest rate outlook. These funds allow the fund manager to invest in short- or long-term instruments depending on his expectations for interest rate movement.

DBFs employ an active portfolio duration management technique, which involves keeping a careful eye on a variety of domestic and global macroeconomic indicators as well as interest rate forecasts.

9. Fixed Maturity Plans (FMPs): 

FMPs are closed-ended debt mutual fund schemes that have a pre-determined maturity date (similar to a term deposit). FMPs that invest in debt instruments with a maturity date that is less than or equal to the scheme’s maturity date are considered debt funds. The investment is redeemed at the current NAV, and the maturity proceeds are returned to the investors after the maturity date.

An FMP’s term might last anywhere from 30 days to 60 months. Because the maturity date and amount are known ahead of time, the fund manager can invest in securities having a comparable maturity as the scheme with reasonable confidence.

If the scheme’s term is one year, the fund manager will invest in debt instruments that maturity immediately before the end of the year. Premature redemptions are not permitted in FMPs, unlike other open-ended funds where units can be bought and sold continuously.

As a result, the units of FMPs (which are closed-ended schemes) are required to be listed on a stock exchange/s so that investors can sell the units on the stock exchange in the event of a liquidity emergency.

10. Monthly Income Plans (MIPs): 

MIPs are hybrid mutual fund schemes that invest in both debt and equity securities, however; they are often debt-oriented mutual fund schemes because they invest primarily in debt securities and just a minor amount (15-25%) in equities.

MIPs provide consistent income in the form of monthly, quarterly, or half-yearly dividend payments. As a result, MIPs are the favored solution for investors seeking consistent income streams.

Monthly income or a regular dividend is not guaranteed or required under MIP’s because the income is paid at the discretion of the mutual fund and is contingent on the availability of distributable surplus from realized gains.

MIP returns can be variable and may suffer losses as a result of the equity exposure, causing dividend payments to be erratic – both in terms of amount and frequency, or perhaps skipping dividend payments entirely. Despite this, MIPs have a track record of giving larger returns after-tax, so they may be a better option.

Investors who are concerned about MIP dividend income fluctuating can choose Growth Option and a systematic withdrawal plan, or SWP, which allows periodical redemption of a pre-determined amount. An SWP that is part of a MIP can provide investors with a steady stream of income. When a person invests a substantial amount of money, SWP works better.

11. Capital Protection-Oriented Fund Scheme: 

Capital Protection-Oriented Funds (CaPrOF) are mutual fund schemes that attempt to protect at least the capital, i.e., the initial investment, while also allowing for further gains based on the fund’s investment objectives.

In a nutshell, it tries to protect the principal while also providing the possibility of equity-linked capital appreciation. It is crucial to realize, however, that there are no guarantees of returns or capital protection.

Capital Protection-Oriented Funds are closed-ended debt funds that typically invest a large percentage of their assets (say, 80%) in AAA-rated bonds and the rest in risky assets such as equity. To hedge against the downside risk, certain funds may invest in stock derivatives.

It is precisely this structure that is aimed toward safeguarding the principal. The debt half of the fund grows to return your capital at the end of the term, while the equity portion provides potential upside.

As a result, even if the stock market crashes, the capital amount is safe. Capital Protection-Oriented Funds are, hence recommended over conventional FMPs. Capital Protection-Oriented Funds are perfect for individuals who want to protect their money against downside risk while also participating in the stock market.

Read Next: “8 Common Myths of Mutual Funds.”

For more information, reach us at support@prudentwealth.in

Team, MyGoalMySip.

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1. Choosing educational funding for children:

When it comes to investing in mutual funds for your children’s future, the basic rules are the same as they are for any other long-term aim. However, simply investing will not suffice in this case. You must be cautious when it comes to the risk management of your corpus, especially if your child is preparing to begin his higher education.

Making the money available at a time when your child needs it is just as vital as investing. As a result, debt funds play an important role in this situation. Investing in stock has numerous advantages when you have time on your side. However, once you’re fewer than three years away from your target, you should maintain a careful eye on the market.

When you’re getting close to your goals, you should de-risk your portfolio to ensure that the profits you’ve made aren’t wiped out. To put it another way, when you get closer to your goal, start shifting from equity to debt to protect your profits.

Based on the interest rate scenario at the moment, you could choose to move away from high-risk options and into liquid and short-term debt funds or somewhat riskier debt funds, such as bond and gilt funds. Short- to long-term bond and gilt funds, for example, would perform well if interest rates were to decline. Stick to liquid funds if interest rates remain stable or rise; they are safer than the rest of the debt schemes, if not the safest of all financial products, and they will still earn you more than your savings bank account.

Step by step – through a Systematic Investment Plan or SIP – is the best strategy to develop enough corpus for your child’s future. It’s best to get started as soon as possible. Of course, you’ll need to stop along the route now and again to make sure everything is going according to plan. The closer you go to your financial goal, the more cautious you need to be to avoid making a mistake.

2. The importance of a debt funds in a retirement portfolio:

As you become older, reduce your equity fund holdings slightly; the aggressive investor should reduce his stock holdings from 80% to 70%, and the conservative investor from 60% to 40%. With around 15 years till retirement, you should begin to play it safe and manage your debt and equity exposure. For example, a conservative investor would choose a debt allocation of 10% to 20% higher. Floating-rate funds and fixed maturity plans are two options for debt. Balanced funds are another debt-equity mix choice for the semi-aggressive investor.

Plan of action:

Follow the life cycle approach to investing while saving for retirement using mutual funds. Maintain a healthy balance of equity and debt as you become older.

With about ten years till retirement, your top concern should be to protect your collected cash. Plan your de-risking approach ahead of time and wait for the right opportunity to move your money from risky stock to safer debt. A major amount of your portfolio should have been transferred away from equity and into debt funds by the time you are 1-2 years away from retirement.

3. Purchasing a home:

Investing in mutual funds not only helps you build wealth but also helps you build assets. They play a vital function in assisting in the construction of one’s most valuable asset—home of one’s own.

Most households, especially those with both partners working, can afford to pay the equated monthly installments (EMIs). The largest challenge, though, remains to accumulate a large lump sum to pay the down payment on the house. Mutual fund schemes come in help in this situation. All renters ask why they should waste their hard-earned money on costs when they could use it to buy a home and build an asset.

That is particularly true now when property prices have likely dropped out and; home loans are readily available, owing to housing finance companies giving low-interest loans to customers. If you plan to buy a property in the next two to three years, mutual fund plans can help you save money, especially for the down payment.

Obtaining monies from friends, relatives, or pawning gold may not be the ideal method for obtaining funds. Prepare ahead of time to avoid relying on such sources as much as possible. Start saving for your down payment if you believe your circumstances are suitable for purchasing a home. Get a sense of how much you can afford to spend and how much you can pay in EMIs. Calculate how much margin money you’ll need, which is typically 20% of the home’s value. After that, figure out how much you need to save each month.

Where should you invest your money?

If your time horizon is shorter than a year or just a year away, you should put your money in a money market or liquid fund. These funds have the lowest volatility because they have no exposure to equities. The goal is to keep the money safe and not take unnecessary risks with it. Select at least two or three debt funds to diversify your portfolio and begin saving using a systematic investment plan (SIP). Even if you’re willing to take a chance, maintain the portfolio oriented toward debt.

Plan out your strategies:

Keep in mind that even debt funds are subject to interest rate risk. So, at least two years before you attain your target, switch to less volatile debt funds, such as short-term debt funds. When you’re only a year away from your objective, put all of your savings into a liquid fund. Your tiny monthly saves may not strain your household budget, but they will add up to a lump sum large enough to cover your down payment requirements for a property.

As indicated in the figure below, investors have a wide range of options for investing based on their risk-return profile and life stage. It should be noted that the schemes chosen are merely examples. A young investor at the outset of her career, for example, may have a higher risk appetite and time horizon, so she would consider investing in long-term debt categories such as monthly income plans, gilt funds, long-term income funds, and credit opportunity funds. The risk-taking capacity of an investor may deteriorate as he or she grows older.

As a result, investing in shorter-term debt funds, such as fixed-term plans, liquid funds, and ultra-short-term debt funds, may be a viable option.

Read Next: “Classification of debt schemes on the basis of duration.”

For more information, reach us at support@prudentwealth.in

Team, MyGoalMySip.

What is Debt Fund?

A debt mutual fund invests primarily in debt instruments or fixed income securities such as Treasury Bills, Corporate Bonds, Money Market Instruments, and other debt securities with different time horizons.

Debt fund securities have a predetermined maturity date and a predetermined interest rate. As a result, debt funds can be counted on to provide a low rate of interest over time. They also have a very low-risk rating. Debt funds are an interesting part of a wise investor’s portfolio because of their safety.

What do the terms Maturity and Duration imply?

When we talk about debt funds, we frequently hear the phrase above. In fact, rookie investors use them interchangeably. Both words may appear to be the same, yet they have different meanings in the financial world. In English, duration refers to the amount of time, while maturity refers to the degree to which something has matured.

• Maturity: 

The term “maturity” refers to how long it will take for a debt instrument’s principle to be repaid. A five-year bond or debt instrument, for example, pays interest for five years from the date of purchase. The maturation period is 5 years in this case. The bond principal is paid back to the owner at the end of the five years, and interest payments are no longer made.

The time between now and when the bond matures is typically referred to as maturity by the investor. A debt instrument’s maturity date is normally fixed at the time of issue and does not alter. The maturity of a debt instrument, on the other hand, shortens as the instrument’s life approaches its maturity date.

• Duration:

Duration is a more abstract and perplexing concept that is used to determine the interest rate’s sensitivity. It means it assesses how sensitive a fixed-income investment’s principal is to interest rate changes.

Bond market investors pay close attention to interest rate swings because they have the opposite effect on bond prices. The value of a debt instrument decreases as interest rates rise, and vice versa. The term “duration” is commonly used to refer to the number of years.

Understanding Duration in further depth:

When employed as an indication, duration is influenced by various factors such as present value, yield, coupon, eventual maturity, and call features. Simply said, the longer the term, the more interest rate risk or reward there is for bond prices.

The notion of duration allows investors to compare bonds and debt funds with a variety of coupon rates and maturity dates. Because the duration is defined in years, a longer duration for a debt-oriented investment means that investors will have to wait longer to get coupon payments and the capital invested. The higher the duration value, the more likely the price of the investment will fall if the interest rate rises. It’s also true in the other direction.

A Case Study:

For example, Rishav is currently deciding on debt funds for his portfolio. His preliminary research indicates that interest rates will rise in the next three years, and he may decide to sell the bond funds before the maturity date. As a result, when investing, he will need to consider the duration, and he may wish to invest for a shorter period of time.

Suppose Shreya wishes to purchase a 15-year bond that yields 6% for Rs. 1,000 or a 10- year bond that yields 3% for Rs. 1,000. If the 15-year security is held to maturity, she would receive Rs. 60 each year and would receive the Rs. 1,000 principal after 15 years. Conversely, if the 10-year bond is held until maturity, Shreya would receive Rs. 30 per year and would receive the Rs. 1,000 principals invested.

Therefore, Shreya would want to consider 10-year bond because the bond would only lose 7%, or (-10% + 3%), if interest rates rise by 1%. However, the 15-year bond would lose 9%, or (-15% + 6%), if rates rose by 1%. However, if interest rates get reduced by 1%, the 15-year security would rise more than the 10-year bond.

Read Next: “Portfolio Management.”

For more information, reach us at support@prudentwealth.in

Team, MyGoalMySip.