Mutual funds are trusts that collect money from the people and invest them in the equity markets, government debt, and corporate debt.
In return mutual funds allot (give) units to their investors. These units derive their value from stocks, debt or a combination of both depending on the financial goal to be achieved.
Based on funds' investment aim, schemes launched by mutual funds are categorised as growth schemes, income schemes, balanced schemes and money market schemes.
The general impression about mutual funds is that they collect money from investors and put them into the equity markets. That would, however, expose investors to unnecessary risks due to volatility of the stock markets.
Hence, a mutual fund -- again depending on their financial goals -- would always assign a fixed portion of their corpus (money collected) to equity and debt so as to diversify (spread) its risks.
Growth/Equity-oriented schemes
Growth schemes invest a significant portion of the money collected in the equity markets. These are called as growth schemes as returns from investment in the stock markets are high.
However, investors of such schemes are also exposed to higher risks because of the inherent risks involved with investing in the stock markets.
They are high-risk, high-return kind of schemes.
A typical growth fund has the option of investing 65-90 per cent of its corpus in equity markets. As equity markets appreciate (move from lower to higher levels) the value of units of such funds also show capital appreciation (increase in value).
The mutual fund unit that you get in lieu of your money is your capital and when the net asset value, NAV, of these units increases, it is considered as capital appreciation.
Growth schemes are for those investors having a good risk appetite and are willing to play the patience game. Such schemes give good returns over the medium to long term (that is 2-5 years).
Birla Advantage Fund run by Birla Sun Life Mutual Fund and Baroda Global Fund run by BOB Mutual Fund are two examples of growth funds.
Income/Debt-oriented schemes
These schemes are for investors who are in need of regular and a steady flow of income stream. Investors get a fixed sum of money on a monthly, bi-annually or on an annual basis depending on the options chosen by them while filling the application form.
A good chunk of such scheme is invested in fixed income securities like corporate debentures (debt instruments issued by companies like say Bajaj Auto that have a high safety rating (lower risk of default) and are very much like fixed deposit schemes of banks) and bonds issued by the Indian government as well as corporate bonds (again like fixed deposits; a bond has a fixed tenure and a fixed rate of interest known as coupon rate).
Though risks in these schemes is much lower than growth schemes the chances of capital appreciation are also lesser. It is a moderate-risk, moderate-returns kind of scheme.
Investors whose risk appetite is not very high can avail of these schemes. Though not affected by wild fluctuations in the equity market the NAVs of income schemes are sensitive to interest rates.
If interest rates go up the value of NAVs of income schemes go down. Their NAVs and interest rates share an inverse relation. The current situation is the case in point as interest rates are on an upward journey.
Again good for long-term investors as interest rate changes even out over a period of 3-5 years.
Franklin Templeton Mutual Fund's FT India Monthly Income Plan and Canbank Mutual fund's CANINCOME are examples of two such schemes.
Balanced schemes
These schemes are a combination of the investment strategies discussed above in the growth and debt-oriented schemes.
Such schemes aim to achieve both regular income and growth (capital appreciation) by striking a balance between their investments in the equity markets and fixed income securities.
They sort of invest 40-60% of their corpus in equity and debt instruments while retaining the rest as idle cash. This idle cash is invested during crises like a stock market crash or sudden upsurge in interest rates.
This strategy of keeping a significant portion as idle cash in balanced schemes help in providing a cushion in volatile times as we are witnessing today in the equity as well as the debt market.
Such schemes are best suited for investors aiming for moderate returns over the medium term (2-3 years). It is a moderate-risk, moderate-returns kind of scheme.
Tata Mutual Fund's Tata Balanced Fund Growth and UTI Mutual Fund's UTI Balance are examples of this scheme.
Money market schemes
This scheme is for those investors who want to earn steady but assured income on their surplus funds in the short-term.
This scheme basically aims to provide easy liquidity (investors can sell the units of these schemes and get cash in lieu). Apart from that investors can rest assured that the money they put in will not reduce in value, that is, it offers capital protection.
The assured income generated from such schemes is the icing on the cake.
Mutual funds offering this scheme invest their corpus in treasury bills (short-term debt instrument offered by the government; say a 30-day fixed deposit offered by a bank), certificates of deposit (same as fixed deposit schemes offered by companies like say ACC), apart from a host of other short-term debt schemes of the government.
This scheme offers highest security and least volatility. However, the returns are lower along with high safety of your principal amount.
Fidelity Mutual Fund's Fidelity Short Term Income Fund and Franklin Templeton Mutual Fund's Templeton India Liquid Plus are the examples of such money market schemes.