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Go Back to Main Page A BEGINNERS GUIDE TO MUTUAL FUNDS

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Mutual Funds - Complexity V/S Classification
There are a large number of mutual funds, but a good categorisation system makes it possible to understand them better

There are plenty of mutual funds in India. Hence it is a difficult task to understand each fund individually before deciding a suitable mutual fund to invest in. However, the task is made simpler if you could divide the funds into categories and sub-categories according to their investment characteristics. You can first analyse which category meets your requirements and then choose individual funds. This makes the task simpler because a large number of funds may be unsuitable to you and hence need not be touched. 

How Mutual Funds Are ClassifiedThe purpose of fund classification is to help investors match their own risk-taking ability and returns expectations with the type of fund that they are going to invest in. The first thing to understand about fund classification is that it is almost entirely about dividing the entire risk-return spectrum into bands of roughly equal return and risk expectations. This makes the task of identifying funds that are likely to generate higher returns at a relatively lower risk, far easier. 

At the broadest level, funds are classified according to the ratio of equity and debt investments in their portfolios. These include pure equity funds, pure debt funds and hybrid funds (that have both equity and debt components). The relative return vs risk levels would be highest for equity funds and lowest for debt funds while hybrids would fall in between. At the next level, the primary way of classifying equity funds would be by the size of the companies they invest in. There are funds that focus mostly on large companies or medium-sized or small companies and there are those that keep their assets distributed among all these in some ratio. There are other axes along which equity funds can be classified, for example, which sector or industry they would invest in. 

The best advantage about having a good classification system for funds is to realise that making a choice is actually quite simple. You may just segregate those that match your risk-return profile and those that don’t. 

SUMMARY

It becomes much easier to understand and choose the right fund if they are classified into different categories. Classification of funds firstly segregates those that should have roughly the same level of risk and expected returns. It is important for investors to compare like-to-like funds while choosing investible funds. Fund Classification must therefore take into account typical investor needs and allow you to choose the most suitable funds.

Next To Come: How To Choose Your First Mutual Fund?