Mutual funds: There's something for each investor; pick what suits you

Owing to their low reliance on market sentiments, debt funds provide consistent returns, ranging between 7-9 per cent per annum. They allocate 65 per cent of their corpus to less volatile debt securities, such as certificates of deposits, debentures, bond papers, etc. Debt funds may not generate as large returns as equity funds, but they also do not fall as quickly as they are less subject to market fluctuations.

Secondly, as debt funds are primarily protected from market volatility with investments made in fixed-income instruments, they are appropriate for cautious investors who want a low-risk investment option. Thirdly, debt funds can be used for emergencies and short-term goals, as investors can redeem them at any point in time, simpler than other fixed-income investing options that could have lock-in periods and penalties for early withdrawals.

Lastly, investors have the option to invest in debt funds by making a one-time lumpsum payment, or use the SIP (Systematic Investment Plans) route, and pay in small regular instalments. They can also use STPs (Systematic Transfer Plans) to move units from one fund to another.

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Risks: Interest rates and credit risk exist even for the best-performing debt funds.

Equity funds: Advantages and risks

Equity funds invest mostly in equities of publicly-traded corporations, and in derivative instruments, such as futures and options. Equity funds are a more volatile asset class than debt, and are appropriate for individuals with a high-risk tolerance.

Returns from equity funds are 12 to 16 per cent per annum, higher in comparison to debt funds in the long term. Equity funds are open to investors with moderately high to high-risk appetites.

What you need to watch out for? Given that equities funds are actively managed by fund managers, their expense ratios are typically substantially higher. Also, since equity funds are prone to market volatility, timing an investment has consequences in the short run. They are an investment option suitable for achieving long-term financial goals, so it is important to stay invested.

ELSS

The Equity Linked Savings Scheme (ELSS) are open-ended equity MFs that invest mainly in stocks, and other securities that have an equity component. According to Section 80C of the Income Tax Act of 1961, they fall under a particular category of MFs that are eligible for tax deductions. When investing up to ₹150,000 yearly, ELSS come with certain tax advantages.

Risks: The main risk influencing equity funds is market risk. Market risk is the chance that a security's value will decline for a variety of reasons that impact the entire stock market.

Also read: Looking for safety, liquidity, healthy returns? The name could be bond

Hybrid funds: Advantages and risks

In order to diversify holdings and reduce concentration risk, hybrid funds invest in both debt and equity assets. An ideal combination of the two provides better returns than a typical debt fund, while being less risky than equity funds.

Returns depend on the hybrid fund type that the investor decides to invest in. Compared to debt-oriented hybrid funds, equity-oriented hybrid funds often provide better potential returns.

Hybrid mutual funds have the advantage of allowing investors to access many asset classes through a single fund, doing away with the need for multiple investments. In order to maximise portfolio diversity, hybrid mutual funds diversify not only across multiple asset classes, but also across sub-classes within each class, such as large-, mid-, or small-cap stocks, as well as between value and growth stocks.

By providing alternatives for conservative, moderate, and aggressive investors, hybrid mutual funds cater to a number of risk profiles.

Risks: Assuming hybrid funds are fully risk-free is not advisable. Any investment vehicle that makes equity market investments brings with it some risk. Although it might be less hazardous than pure equities funds, investors should still use caution and routinely rebalance their portfolios.

With the stock markets on a roll, investors are flocking to buy equity schemes, said Manish Mehta, Head - Sales & Marketing, Kotak Mahindra AMC. “Investors continue to invest in equity schemes using the SIP and SWP routes. These tools help investors leverage their purchases,” he added.

“The mutual fund industry has witnessed encouraging growth over the years. Thanks to various investor awareness programmes, there is increased knowledge about mutual funds. Investors need to plan their investment horizon, risk-taking ability, and plan the right asset allocation. Investments through SIP are suitable for building long-term wealth,” he added.

Priti Rathi Gupta, founder & MD, LXME, shares some advice. She said, “Interest rates have increased, but so has inflation. Equity markets have hit new highs. India is a growing economy, therefore, the markets will continue to grow if you take a long-term perspective. In order to become a smart investor, each of your investments should be tied down to your financial goals and optimising returns. In the long run, a mix of asset classes is required in one’s portfolio to cater to short-term and long-term goals.”

“Debt investments add stability to your portfolio. Therefore, irrespective of rising interest rates, a part of your money must be used for investing in debt funds. An allocation towards equity is also important, from the perspective of earning inflation-beating returns in the long run. A small portion - 5-10 per cent - of the portfolio can be allocated to investment in gold, as it acts as a hedge against inflation,” she added.

(This article is meant to provide information, and does not constitute investment advice.)