If you're a first-time investor or simply want your portfolio to be professionally managed, then you should opt for mutual funds. They allow you to pool your money for a diversified selection of securities. Mutual funds provide you with expertise, diversification, liquidity and the ability to manage inflation. There are a wide variety of mutual funds available. However, they can be broadly divided into the following three main categories:
These funds invest in the stocks of a variety of industries or they may focus on a particular industrial sector. The objective of such funds is long-term capital growth. In effect, under such schemes, you become a part owner of every security in your portfolio. These funds carry high risks due to the volatility of the stock market but can also provide great returns over time.
Fixed- income funds
These funds invest in securities like bonds and gilts. The objective of these funds is to provide the investor with a current, stable income. Bonds can be considered as loans in which the investor is the lender and the organization is the debtor. Gilt funds invest in government securities and are thus, safer than bonds. Fixed-income funds are less volatile than equity funds and are lower on risk. They only provide moderate returns, but ensure safety of capital.
Dynamic bond funds invest solely in fixed-income instruments. The fund manager actively manages the portfolio duration of these funds, based on his interest rate predictions. This flexibility helps protect the investor from market volatility.
Money market funds
These funds invest in short-term debt instruments. The objectives of such funds are capital preservation and income. The returns are not sizeable compared to other types of mutual funds. However, they can earn about twice the amount as a regular savings account would. In addition, there is little risk involved and you won't need to worry about losing your principal amount. They also have high liquidity. All in all, such funds are ideal for a cautious investor.
Balanced funds have a combined objective of providing a current income source as well as long-term capital growth. Such funds generally invest about 40% in fixed-income and 60% in equities. This added diversification helps to spread the risk further.
Unit Linked Insurance Plans are similar to mutual funds. However, they combine the benefits of both insurance and investments. Such plans are provided by insurance companies and allow you to invest a portion of your premiums into different types of funds. They also boast tax benefits under section 80C. ULIPs however, have limited liquidity as they require you to stay invested for the specified period of the policy.