Financial advisors will generally advise you, “do not keep all your eggs in one basket.” Such an investment action is denoted as diversification in the parlance of personal finance. Diversification refers to making an investment portfolio across different investment segments and asset classes to reduce the overall investment risk.
Different asset classes may react differently to similar macroeconomic events. For example, the recent corporate tax rate cut announced by the Finance Minister was cheered by the equity markets, but the debt markets got cautious due to expected fiscal slippages and higher government borrowings on this account. As such, having a diversified investment portfolio helps the investors to reduce their investment exposure to a single asset class. Different asset classes like equity, debt, gold, etc. have their respective economic cycles, and hence, the investors can stand to gain from the cyclical uptrends in different asset classes.
Mutual funds ease the process of asset allocation for the investors, as the mutual funds offer a wide range of mutual fund schemes to invest to invest. Further, since the mutual funds pool the money invested and invest in a basket of securities, automatically rendering diversification to the portfolio. Here are different types of mutual funds to invest in:
1. Equity Funds
Such funds invest at least 65% of their net assets in equity and equity-related securities. Even within the overall universe of equity funds, investors get to choose from wide range of diversified equity funds. Equity funds may further be categorised into large-cap funds, mid-cap funds, small-cap funds, large & mid-cap funds, focused funds, sectoral/ thematic funds, dividend yield funds, multi-cap funds, value funds, Equity Linked Savings Schemes (ELSS) and contra funds. Therefore, the investors may choose to invest across market capitalisations, investing strategies, etc. and even diversify their equity portfolio.
2. Debt Funds
Debt funds predominantly invest in debt securities. Just like different categories of equity funds, even the debt fund universe has a wide range of offerings such as liquid funds, overnight funds, short-duration funds, low duration funds, money market funds, dynamic bond funds, long-duration funds, corporate bond funds, credit risk funds, gilt funds and floater funds. So, the investor may choose to invest in the debt funds suiting their investment horizon, interest rate outlook and risk appetite.
3. Hybrid Funds
Such funds create a hybrid investment portfolio spanning across more than one asset class. Such funds may be classified as multi-asset funds, balanced advantage funds, arbitrage funds etc. Therefore, hybrid funds render the benefit of diversification across asset classes with a single fund.
4. Solution-Oriented Funds
As the name suggests, such funds aim to cater to the investment needs specific to certain financial goals, e.g., children funds, retirement funds, etc. Considering the long-term horizon for such financial goals, solution-oriented funds generally come with a lock-in period, which may differ with different funds.
Other Funds
This is the other category of mutual funds, which encapsulates the remaining types of the available mutual fund schemes. Such funds may include Exchange Traded Funds (ETFs), Index funds, Fund of Funds (FoFs), etc. ETFs may be another great investment product for the investors, as ETFs provide passive investment exposure to major indices and commodities like gold etc. with a single investment product.
Mutual funds render the benefit of professional fund management to the investors, thereby mitigating the personal bias and investment risk for the investor. Targeting diversification with mutual funds may thus help the investors for further mitigating the investment risks by spreading the risks across different investments and securities.