August 22 , 2012
There are different types of mutual funds schemes. The best way to classify mutual funds is to look at what it contains. If it contains stocks, it is an equity mutual fund, and similarly there are gold and debt mutual funds. If it contains more than one type of item inside (like your box containing chocolates and sweets), it is a hybrid mutual fund. A chocolate is not going to taste too very different in different boxes. So a mutual fund carries the same profile as what it contains - in terms of risk and return and other parameters.
As with equities, an equity mutual fund carries higher risk, but can also deliver higher returns. This is ideal when the horizon you are investing for is long, say greater than seven years. As with deposits and bonds, a debt mutual fund is safer and gives lower returns. This is ideal for investments you want to break within five years. The gold mutual fund is a good way to invest in gold, rather than buying coins or biscuits and worrying about their quality and safety.
Now you can go deep within each of these types and look at different sub-types within. But for now, we will look at only one sub-type, which is the index fund. This is a type of equity fund that simply copies the index (BSE Sensex or NSE Nifty). It holds the same stocks as the index, in the same proportion. No element of fund manager choice is present here, and hence no research is required to identify a 'good' index fund. This fund is the best first investment for a beginner, as we shall see later.
There are a few other ways to classify mutual funds, but these are less important for a beginner. One deals with whether you can redeem the fund anytime, or whether it has a fixed maturity time when you can redeem. We will only deal with the former (called open ended funds) as of now. Indeed, most funds today in the market are open ended.
What we shall see now is not really a 'type' of mutual fund, but an option within it. Something like having a side opening sweet box, versus a top opening one. There are two options: the 'growth' options means that your gains stay in the fund and keep appreciating as the fund does well. The 'dividend' option means that your gains are periodically paid out to you. You can choose to take these dividends home 'Dividend Payout' or plough them back into the fund 'Dividend Reinvestment'. The choice is simple: if you are retired and are using the investment to get regular income, go for the 'Dividend' option. Otherwise, let the fund managers continue their good work, and go for the 'Growth' option.