Mutual funds are one of the most preferred investment options in the Indian financial markets. With various categories of mutual funds on Dhan, it can sometimes be confusing for an individual to decide which one to choose. It is essential for one to know the categories of mutual funds in the Indian markets to decide which mutual fund suits them best according to their needs.

In this blog, we will discuss the types of mutual funds on the basis of several classifications and the factors to consider while selecting the right mutual funds.

Classification of mutual funds in India

In India, mutual funds are broadly classified by the Securities and Exchange Board of India (SEBI) to introduce standardisation, transparency, and clarity for investors. This would enable an investor to know clearly about what a fund does, where it invests, and its risk-return profile before arriving at an investment decision. In a broad spectrum, mutual funds can be classified based on the following parameters:

• Asset class
• Investment objective
• Structure

Each of these classifications caters to a different investor's needs and risk profile, making it easier for investors to build a well-diversified and goal-oriented mutual fund portfolio on Dhan.

Types of mutual funds based on asset class

The different categories of mutual funds based upon the asset type ar

Equity mutual funds

Equity mutual funds mainly invest in the stocks of listed companies. Equity mutual funds are primarily used for long-term growth and are best suited for investors with a higher risk tolerance and a long investment horizon. Based on the type of stocks that equity mutual funds invest in, the equity mutual funds are further classified into various sub-categories, which are:

• Large-cap funds: These funds invest in stable, financially strong, and well-established companies with large market capitalisation. They offer relatively lower risk as compared to other types of equity funds and provide steady and more predictable returns.
• Mid-cap and small-cap funds: They primarily invest in new, emerging, and fast-growing companies. Even though they have higher growth prospects, they come with high volatility and can see sharp fluctuations in market downturns.
• Multi-cap and flexi-cap funds: These mutual funds allow flexible investing in large, mid, and small-cap stocks. The fund manager can change the portfolio allocation depending on the market conditions and investment opportunities in the stock market.
• Sectoral and thematic funds: These funds invest in a particular sector, such as banking, IT, and infrastructure, or follow a theme such as consumption and digitalisation. Though they can give superior returns in favorable market cycles, they also pose concentration risk.

Equity mutual funds are best suited for investors having long-term financial plans, like accumulating wealth, retirement planning, or fulfilling big milestones.

Debt mutual funds

Debt mutual funds invest in fixed-income instruments like government securities, treasury bills, corporate bonds, commercial papers, money market instruments, etc. Debt mutual funds aim to offer steady returns with lower risks involved as compared to equity mutual funds. Debt mutual funds can be categorised into different categories based on the maturity level and credit risk exposure. Here are some debt mutual fund categories:

• Liquid and overnight funds: These funds invest in very short-term instruments with their maturity dates ranging from one day to a few months only. These funds are preferred when one needs to temporarily park excess funds without incurring higher risk.
• Short-duration and corporate bond funds: These types of funds invest in debt securities and corporate bonds of slightly longer maturity periods. Their strategy is to provide a mix of stability and superior returns compared to liquid funds.
• Gilt funds: They invest in government securities, which carry no credit risk, but are vulnerable to interest rate changes. They offer higher returns during declining interest rates, but can be volatile in the short term.

Debt funds are best suited for conservative investors or retired investors who need regular income. Debt funds can also be suitable for short- to medium-term investing objectives with lower risk and relatively predictable returns.

Hybrid mutual funds

Hybrid funds invest in a mix of equity and debt instruments that balance growth and stability. By diversifying across asset classes, these funds minimise the overall volatility of a portfolio while still providing growth potential. The equity-to-debt mix differs depending on the objective of the fund. Hybrid funds are further classified based on asset allocation strategy, such as:

• Aggressive hybrid funds: These are funds that invest a major part of their portfolio in equities, at least 65%, with the rest of the investment in debt instruments. They are best for investors who want higher growth than pure debt funds but with lower risk than equity-only funds.
• Conservative hybrid funds: With a higher allocation to debt (75% to 90% of their total assets) and a smaller equity exposure, these funds are focused on stability and regular income, with limited upside offered by equity investments.
• Balanced advantage (dynamic asset allocation) funds: These funds dynamically change their equity and debt exposure depending on the valuations of the markets, volatility, and economic conditions. This flexibility helps manage downside risk during market corrections and exploit opportunities during market rallies.

Hybrid mutual funds are best suited for investors looking for moderate risk, smoother return profiles, and a disciplined asset allocation approach without the need to manage equity and debt exposure themselves.

Types of mutual funds based on investment objective

The different types of Mutual Funds, according to the investment objective, are:

Growth funds

The main goal of growth-oriented mutual funds is to invest in companies that have high growth potential. These funds are suitable for young investors seeking higher returns and have high risk tolerance.

Income funds

Income funds aim to generate regular income through the primary allocation of investments in debt instruments. They are well- suited for the investor searching for stable income with lower market volatility.

Equity-linked savings schemes (ELSS)

These are tax-saving funds as they come with tax advantages under Section 80C of the Income Tax Act. These mutual funds come with a mandatory locking period of 3 years and invest heavily in equities. ELSS funds are ideal for those individuals who are searching for investments with both tax savings and wealth creation objectives.

Types of mutual funds based on structure

The different categories of mutual funds on the basis of their structure are:

Open-ended funds

Open-ended mutual funds allow the investors to purchase and sell units at any time and at the prevailing Net Asset Value (NAV). Open-ended mutual funds are highly liquid and flexible.

Close-ended funds

It is closed-ended because it has a fixed maturity period. The subscription is made only during the offer period, after which the units start being listed on stock exchanges.

Interval funds

Interval funds are those that possess both open-ended and closed-ended funds qualities, redeemable only within stipulated time intervals.

Other popular types of mutual funds

In addition to the major categories, many other types of mutual funds exist to serve niche investment strategies or asset classes. Some of them are:

• Index Funds: These are passively managed funds that seek to replicate the performance of a specific market index, such as the Nifty 50 or Sensex. They provide diversification at reduced prices as compared to other funds.
• Exchange Traded Funds (ETFs): ETFs are traded on a stock exchange in the same way as individual shares but are managed like an index fund.
• Fund of Funds (FoFs): These funds do not invest directly in securities but rather invest in other mutual funds, offering diversification.
• International Funds: These are funds that invest in equities or debt securities of foreign listed companies, and they offer geographical diversification.

These funds are suitable for investors seeking passive investing or international exposure.

How to choose the right type of mutual fund?

The selection of the right type of mutual fund requires an evaluation of your individual financial health and investment objectives. Take into account the following factors:

• Investment Objective: Set a clear goal of what you want to achieve with your investment, whether it is long-term wealth creation, short-term income, or a specific life goal.
• Risk Tolerance: Determine how much risk you are comfortable with investing in. An increased risk investment often carries higher potential returns, but with increased volatility.
• Investment Horizon: Decide the duration for which you want to invest, whether it is long-term, medium-term, or short-term.
• Financial Situation: Evaluate your present income, spending, and what you have invested before to know how much you can comfortably invest.
• Expense Ratio: This is the annual fee charged by the fund house. A lower expense ratio implies that you will receive higher overall returns.
• Past Performance: Past performance is not predictive of future performance; however, it can give you valuable insights regarding how a fund has performed in different market conditions.

Final thoughts

In India, mutual funds provide a wide diversity of choices to meet different financial objectives, risk profiles, and time horizons. Whether it is equity funds that aim to provide higher growth, debt funds offering stability, hybrid funds offering a balanced approach, or International funds offering global exposure, etc., each fund type serves a different purpose.

The first step towards building a successful mutual fund portfolio is to develop an understanding of the types of mutual funds and their objectives. Mutual funds can contribute to long-term financial success through clarity and informed decisions.

FAQs

1. What is the taxation for asset-based mutual funds in India?

Tax is determined by the type of fund and the retention period. For example, funds invested in equity funds over a period of one or more years will be taxed as long-term capital gain, and funds invested for less than one year will be taxed as short-term capital gains, whereas funds invested in debt funds will be taxed depending on the income tax slabs of the investor. Additionally, the taxation of hybrid funds is based on equity distribution, hybrid funds with ≥65% equity funds are taxed like equity funds and hybrid funds with ≥65% debt funds are taxed like debt funds.

2. Are hybrid funds better than pure equity and debt funds?

Hybrid funds offer convenience to hands-off investors because of their automatic rebalancing and professional asset allocation. Conversely, allocation, fund choice, and tax optimisation are more controlled when investing in pure equity and debt funds, as they can be rebalanced according to market conditions. Choose hybrid funds for simplicity, or pure equity or debt funds for more control over your portfolio.

3. Is it possible to invest in more than one type of mutual fund simultaneously?

Yes. Investors can invest in various categories of mutual funds, including equity, debt, and hybrid funds. It helps investors in diversifying their portfolio investments, which reduces the overall portfolio risk and ensures that investors can capitalise on different market movements.

4. Are mutual funds safe investments?

SEBI regulates mutual funds, and they are transparent and structured. However, they are not risk-free. The risk a mutual fund carries depends on the type of securities and the duration it invests in. For example, debt funds tend to be less risky than equity funds due to their investments in fixed-income securities.

5. What are SIPs in mutual fund investment?

Systematic Investment Plans (SIPs) allow periodic fixed investments in a specific mutual fund. It enables investors to benefit from rupee cost averaging, builds investing discipline, reduces market timing risk, and compounds returns over time. SIPs can be started with small investment amounts like ₹500/month across most funds, making mutual fund investments accessible to all.