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Mutual Funds Decoded – Your ultimate guide to this financial cushion [Part 1]

types of mutual funds

In an environment of economic uncertainty, every novice and risk averse investor is on the lookout for a way to hedge his investments. It’s quite natural to feel this way. Professionals and businessmen put in years of hard work amassing a considerable sum of money to fulfill their long term and short term financial goals. In such an environment, when stock markets are volatile, and there is no guarantee about which organisation may be filing for bankruptcy while we speak – Mutual Funds, are what emerge as the ultimate financial float.

When investing in a Mutual Fund, a newbie investor will come across a variety of options. Debt, Index, Gilt, Equity! – What are these? and which one best suits your goals? In Part 1 we talk about the lowest risk mutual funds that a new investor can fix his money in –

Gilt Mutual Funds

While it sounds complicated, Gilt Mutual Funds are simply put mutual funds, where money pooled in by investors is invested exclusively in government securities or G-Secs aka bonds issued by government companies. In a well diversified portfolio where there is a sum of investments apportioned for mutual funds, Gilt mutual funds forms a part of the ‘risk-free investment bracket’. Though returns in a gilt mutual funds are not as exciting as equity mutual funds, these funds offer better asset quality and more security. Thus, peace of mind!

Pros and Cons

As pro’s we are looking at zero risk, tax free investments that are completely independent of how the stock market performs. However, as the rate of return on Gilt Mutual Funds are determined as per the repo rate of the RBI. If the RBI keeps the repo rate standard, it is a good investment. However, in the current economic scenario where the RBI has provided rate cuts consecutively on a bi-monthly basis the ‘risk free’ nature of Gilt Mutual Funds is questionable. Although, if you are a complete risk averse investor, this form of mutual fund is better and more profit gearing compared to interest rates provided by bank deposits.

Who Should Invest?

Risk averse investors who are comfortable with a low return in exchange for a totally risk free investment should opt for Gilt Mutual Funds. These funds are also ideal for individuals looking to create a slow and steady retirement fund.

Debt Mutual Funds

If you categorize as per the risk return ratio – Debt funds, come a close second place. A little more ‘riskier’ than Gilt Funds, though relatively safer than other types of investments. These are fund that invest their pool in fixed income securities like bonds, debentures and fixed deposits. The returns in debt funds are fixed and in an event of liquidation, debt holders are given preference over equity holders.

Pros and Cons

Risk free with a fixed rate of return. The rate of return is not determined by the stock market fluctuation and thus a volatile market will not directly impact the rate of the securities. Though this is relatively more risky than G-Secs because the money is pooled into other companies and not government corporations, it still makes a strong case for being a risk free security.

Who Should Invest?

Investors, who have a fixed income and little knowledge about mutual funds – who don’t want to risk their money in the stock market can invest in debt mutual funds.

Index Mutual Funds

Index funds or Exchange Traded Funds are essentially funds that choose a certain index and invest in all the companies in that index. For example a fund may choose the Nifty or Sensex and invest in all companies in that index in the same proportion. These funds provide an amazing diversification of funds, since the portfolio includes shares from all sectors. Mostly passive, the rate of return on these funds depends on the overall fluctuation of the index and not individual companies.

Pros and Cons

Pros – Index funds are relatively risk free, though not as much as Gilts and Debt mutual funds. There are various tax benefits that are provided by different countries on returns on these funds and it gives the investor a chance to invest their money in securities of big global corporations which they otherwise wouldn’t be able to do.

Due to the low risk involved in index funds, the returns are also low. This can be a barrier for an investor who is willing to make a fast profit or has an expectation of high returns.  Index funds are also less flexible in their portfolio management policies.

Who Should Invest?

Investors looking to create a retirement fund (a la Warren Buffet!), individuals looking for a low risk highly diversified portfolio, and people in general who want to invest in the markets and reap its benefits, but do not want to get into the hassle of researching on the working of the stock market can lock their money in index funds.

So, in Part One we spoke about risk free funds in descending order. While mutual funds enjoy the reputation of being risk free, there are some which do offer a slightly tempting rate of return with a higher risk exposure – We talk about this in Part 2 of Mutual Funds decoded.

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