Whenever we look for “Different types of mutual funds,” we come across a huge number of options such as equity, debt, and hybrid funds. This can be a little overwhelming for an everyday individual.
We have seen many people search for “Best Mutual Funds” online and invest blindly, without checking whether the fund actually suits their goals or risk appetite. This approach is completely wrong. This blog will help you understand each type of mutual fund in simple language, along with examples and use cases, so you know exactly what each type does.
What Are Mutual Funds in Simple Terms?
Mutual Funds are investment vehicles where the mutual fund companies collect money from many investors and invest it in stocks, bonds, or a mix of both, depending on the category. A professional fund manager handles decisions such as what to buy, when to buy, and when to sell, along with research and risk management. Basically, the fund manager does everything on behalf of the investor.
Mutual fund companies charge a fee for these services, called the expense ratio, which can be up to 2.25%
Broad Categories of Mutual Funds
There are three major categories in the mutual fund industry. In addition to these, there are also some solution-oriented and other categories.
Let’s break it down :
1. Equity Mutual Fund
These funds invest mostly in stocks, and hence come with higher risk. The performance of these funds depends on the share prices of the stocks selected by the fund manager. The skill, experience, and ability of the fund manager can make a significant difference.
Equity funds are meant for long-term wealth building. Investors may face short-term losses, so these funds are preferably suitable for goals of five years or more.
Types of Equity Funds:
Large Cap Fund
Large cap funds are considered one of the least volatile categories within equity mutual funds. This is mainly because they invest in India’s top 100 companies, such as Reliance, TCS, Asian Paints, and HDFC Bank.
Large cap companies are seen as less volatile because of their large market size and strong financial capacity. However, just because these companies are bigger does not guarantee fixed or steady returns. Still, large cap funds can be a good starting point for first-time investors.
One downside of large cap funds is that, over longer periods, they often generate lower returns compared to mid cap or small cap funds. This is why diversification is important when investing in equity mutual funds.
Mid Cap Fund
This category is considered riskier than large cap funds, but it can also generate better returns over the long term compared to large cap funds. Companies ranked from 101 to 250 in terms of market capitalization are classified as mid cap companies.
Since these companies are smaller than large cap companies, mid cap funds tend to be more volatile. Mid cap companies usually have much higher growth potential than large cap companies. Even though mid cap funds may offer better returns, it is not ideal to invest in just one category. Always try to diversify your portfolio to balance returns and reduce the impact of market volatility.
Small Cap Fund
Small cap funds invest in companies ranked 251 and below in terms of market capitalization. This is the most volatile category, as it focuses on some of the smallest companies in India. That said, it cannot be ignored that small cap mutual funds have often delivered higher returns compared to the other two categories.
Small cap funds have become very attractive to many investors, especially after COVID. Some funds have shown returns of more than 25% CAGR. However, it is important to understand that such returns are not sustainable, and over time, there can be sharp corrections.
Small cap funds are not ideal for first-time investors. These funds are better suited for investors who have experience and a good understanding of market volatility. Taking expert advice can be helpful. If someone has a very long-term goal, such as 15 years or more, they may consider allocating a small portion of their investment to small-cap funds.
Multi Cap Fund
This is an ideal category for young investors who do not have a lot to invest, have just started earning, and are trying to put some of their earnings into an SIP. These funds must invest at least 25% each in large cap, mid cap, and small cap stocks, while the remaining allocation depends on the fund manager.
Multi cap funds are diversified by default, so young investors do not have to manage diversification on their own. While this diversification can be helpful for some, it may not be ideal for aggressive investors. These funds can also miss out on strong market rallies because they cannot practically invest more than 50% in a single category. For example, if the large cap category rises by 10% and a multi cap fund holds only 50% in large caps, the fund will capture only part of that rally. This is where the next category comes in.
Flexi Cap Fund
If multi cap funds are good for starting out, you can think of this as an upgraded version. In a flexi cap fund, the fund manager can freely choose companies from any category. For example, if the fund manager believes small cap stocks will perform better, they can invest more in the small cap category.
Compared to multi cap funds, this approach is more aggressive. However, it can also work the other way around. Markets are hard to predict, even for experienced fund managers. If you are just starting your investment journey, it is always better to diversify your portfolio.
Large and Mid Cap fund
At least 35% of the investment must be in large cap stocks and another 35% in mid cap stocks. The remaining portion depends on the fund manager, who may choose to invest more—up to 50%—in large cap stocks if they wish.
Dividend Yield Fund
These funds invest in stocks that pay dividends from time to time. They invest at least 65% of their assets in stocks.
Focused Fund
As the name suggests, this category of funds focuses on a limited number of stocks, with a maximum of 30 holdings. At least 65% of the investment is in equity and equity-related instruments.
ELSS (Tax-Saving Mutual Funds)
Equity Linked Savings Scheme (ELSS) offers tax benefits under Section 80C, up to ₹1,50,000, with a lock-in period of three years. Since this is an equity mutual fund, the returns and risks are similar to other equity funds. Please note that if you start an SIP in an ELSS fund, each instalment is locked in for three years.
ELSS funds are ideal for people who want to save tax while investing. The invested amount can be deducted from your taxable income, but you will have to pay capital gains tax when you sell or withdraw the investment. However, under the new tax regime, there are no Section 80C deductions. So, if you are filing taxes under the new regime, ELSS will not provide any tax benefits. It is important to review your income and tax plan before investing in ELSS funds.
Sectoral & Thematic Fund
These are not your usual large, mid, or small cap funds. They can invest in a single sector or multiple sectors, regardless of market capitalization, such as banking, IT, or the PSU sector. If a fund invests only in one sector, like banking, it is called a sectoral fund. If it invests in multiple sectors around a common idea, it is called a thematic fund. For example, an infrastructure fund may include sectors such as banks and PSUs.
Keep in mind that these funds are not well diversified, so the risk involved is much higher than usual. They are better suited for experienced investors who understand the stock market. If you still want to invest in these funds, it is safer to do so in small portions.
Value Fund(Strategy Based Fund)
Value funds are a type of equity mutual fund that invests in stocks believed to be undervalued in the market. These are companies whose current stock prices are lower than their intrinsic or true value, based on financial metrics like earnings, book value, or cash flow.
Fund managers look for stocks that are trading at a discount compared to their estimated worth. They invest in these stocks, expecting the market to eventually recognize their value, which could lead to price appreciation over time.
In value funds, fund managers use valuation parameters to identify undervalued stocks. Some of the key metrics they look at include:
- P/E ratio
- P/B ratio
- Dividend yield
- Free cash flow
Contra Fund
Contra funds are equity funds that take a contrarian view of the market. They invest in underperforming stocks and sectors at lower price levels, with the belief that these may perform well in the long run. These funds carry the risk of getting market calls wrong, as trends are hard to predict before they actually happen.
As per SEBI guidelines a fund house can either offer a contra fund or a value fund, but not both.
2. Debt Mutual Fund
Debt funds invest in government bonds, treasury bills, corporate bonds, and money market instruments. Because of this, they are considered safer than equity mutual funds. These funds are suitable for short-term goals. They usually offer better returns than a savings account and do not have a lock-in period like fixed deposits. However, some bonds can still default, which is where the role of the fund manager becomes important. Fund managers select bonds carefully to manage this risk.
Debt funds typically generate annual returns in the range of 6–8%. If you need to park your money for a few weeks or a few months, debt funds can be a good option.
Popular Types of debt funds:
Overnight Fund
These funds invest in securities with a maturity of one day. They are ideal for parking money for a very short duration and carry very low risk.
Liquid Fund
These funds are suitable for parking money for a few days to a few months. Liquid funds usually invest in bonds with very short maturity periods, typically up to 91 days. They are also ideal for creating an emergency fund with very low risk.
Ultra Short Duration Fund
These funds invest in debt and money market instruments. If your goal is three to six months, this option can be suitable for you. They can generate stable returns, usually better than a savings or current account.
Low Duration Fund
These funds primarily invest in debt and money market instruments with maturity periods ranging from six to twelve months.
Money Market Fund
These funds invest in short-term instruments such as commercial papers and treasury bills. They are slightly less risky than short-term funds and usually generate better returns than overnight funds. These funds are ideal for a time period of three months to one year.
Short Duration Fund
These funds invest in government securities and high-quality corporate bonds. They can offer better returns than fixed deposits and are ideal for goals of one to three years with relatively low risk.
Medium Duration Fund
These funds invest in debt and money market instruments with maturity periods of three to four years.
Medium to Long Duration Fund
These funds mostly invest in the same instruments as medium-duration funds, but with a longer maturity period of four to seven years.
Long Duration Fund
These funds invest in debt and money market instruments with maturity periods of more than seven years.
Dynamic Bond
These funds actively change the duration of their portfolio based on interest rate movements and market conditions.
Corporate Bond Fund
These funds invest at least 80% of their assets in corporate bonds rated AA+ or higher.
Credit Risk Fund
These funds invest at least 65% of their assets in corporate bonds rated AA or lower, so the risk is slightly higher than corporate bond funds.
Banking and PSU Fund
These funds invest at least 80% of their assets in debt instruments issued by banks, Public Sector Undertakings, Public Financial Institutions, and municipal bonds.
Gilt Fund
These funds invest only in government securities, so there is no default risk involved. However, there can be some interest rate risk, as the RBI may change interest rates from time to time. They can be a good alternative to fixed deposits and corporate bonds.
Gilt Fund With 10 Years Constant Duration
These funds invest at least 80% of their assets in government securities, with a portfolio maturity of around 10 years.
Floater Fund
These funds invest at least 65% in floating rate instruments, including fixed-rate instruments converted to floating-rate exposures using swaps or derivatives.
3. Hybrid Mutual Fund
Hybrid mutual funds invest in a mix of equity and debt instruments. They generally offer better returns than debt funds while carrying lower risk than equity funds. These funds are ideal for retired individuals who want better returns than fixed deposits and are willing to take some risk.
Types of Hybrid Funds:
Aggressive Hybrid Fund
As the name suggests, these funds have an aggressive approach, with 65–80% of the portfolio allocated to equity. This approach can generate higher returns, but the risks associated with equity should not be ignored.
Conservative Hybrid Fund
This is the opposite of aggressive hybrid funds. These funds invest 75–90% in debt and are ideal for low-risk investors who want slightly better returns than fixed deposits.
Balanced Hybrid Fund
These funds invest 40–60% in equity and equity-related instruments and the rest 40–60% in debt instruments.
Dynamic Asset Allocation or Balanced Advantage Fund
This is one of the most popular categories among hybrid funds. These funds can automatically switch between equity and debt based on market conditions. For example, when the market becomes expensive, the fund manager may reduce equity exposure and increase debt allocation. The performance of these funds depends on the fund manager’s skill and experience.
If someone does not want to time the market or deal with the hassle of switching funds, this category can be a good option.
Multi-Asset Fund
Multi-asset funds are also quite popular within the hybrid category. As the name suggests, they invest in multiple asset classes. These funds typically invest in equity, debt, and gold. Do not expect equity-like returns from these funds. Multi-asset funds are mainly for diversification across different asset classes.
Arbitrage Fund
Arbitrage is the simultaneous buying and selling of an asset to take advantage of price differences in two markets. The profit comes from the difference in the price of the same asset across markets or in different forms.
An arbitrage fund buys a stock in the cash market and at the same time sells it in the futures market at a higher price to earn returns from this price difference. This usually happens across exchanges such as the BSE and NSE.
The fund takes equal and opposite positions in both markets, which helps lock in the price difference. These positions are held until the derivative contract expires, and both positions are closed at the same price to realize the gain.
By the end of the contract period, the cash market price and the futures price tend to converge. Because of this, arbitrage funds aim to generate low-risk returns. Any price movement is balanced out, as gains in one market are offset by losses in the other.
Since the fund invests its own capital, the price difference earned becomes the return. This makes arbitrage funds a good option for cautious investors who want to benefit from market volatility without taking on high risk.
Equity Savings Funds
These funds invest in a combination of equity for growth, debt instruments for stability, and arbitrage positions to reduce risk. As per SEBI rules, the net equity exposure (including arbitrage) is kept above 65%, which allows these funds to be taxed like equity funds. Compared to pure equity funds, they are less volatile, while still offering better return potential than pure debt funds.
There is no lock-in period, making them suitable for conservative investors who want limited equity exposure, tax-efficient returns, and slightly higher returns than fixed deposits without taking on high volatility.
4. Solution-Oriented Fund
This category is designed for specific goals or plans, such as retirement or a child’s education.
Retirement Fund
Retirement funds are designed to help investors build long-term wealth for retirement. They usually come with a lock-in period of five years or until retirement age. In some cases, they also offer tax benefits. These funds follow a hybrid approach by investing in a mix of equity and debt to help protect wealth.
While these funds may not deliver returns like pure equity funds, they can help create long-term wealth with relatively stable returns.
Children’s Fund
These funds are designed for long-term goals such as education. They are also hybrid funds that invest in both equity and debt instruments. They come with a lock-in period of five years or until the child turns 18, whichever is earlier.
5. Other Popular Mutual Fund Categories
Index Fund
These funds are ideal for someone just starting their investment journey. Index funds track an index such as the Nifty 50 or Sensex and aim to deliver returns similar to that index. They are also popular because of their low expense ratio.
Keep in mind that index funds are passive funds, as they are not actively managed. Because of this, actively managed funds may sometimes outperform index funds.
Exchange-Traded Fund (ETFs)
ETFs are similar to index funds but are traded directly on stock exchanges such as the BSE or NSE. Some popular ETFs include the Nifty 50 ETF and Nifty Next 50 ETF. It is a marketable security that tracks an index, a commodity, bonds, or a basket of assets, similar to an index fund. ETF units must be held in demat form.
ETFs are passively managed, which means the fund manager makes only small, periodic changes to keep the fund aligned with its index. Since ETFs do not try to outperform the index, they have lower administrative costs compared to actively managed funds. They are suitable for investors who want index-like returns with stock-like liquidity.
Gold Exchange Traded Fund
Gold ETFs are exchange-traded funds where gold is the underlying asset. The scheme issues units backed by gold holdings, and each unit represents a defined quantity of gold, usually one gram.
These schemes hold gold in the form of physical gold or gold-related instruments approved by SEBI. They can also invest up to 20% of their net assets in the Gold Deposit Scheme offered by banks. The price of Gold ETF units generally moves in line with the price of gold on the metal exchange.
Benefits of Gold ETFs
- Convenience – Allows you to hold gold electronically instead of physical gold.
- Safer option – No risk of theft or purity issues.
- Easy liquidity – Simple buying and selling with ease of transactions
Fund of Fund(FoF)
Fund of Funds (FoF) are mutual fund schemes that invest in units of other mutual fund schemes, either from the same fund house or from different fund houses. The schemes selected for investment depend on the investment objective of the FoF.
FoFs have two levels of expenses: one from the schemes in which the FoF invests and another from the FoF itself. Regulations limit the total expenses charged across both levels as follows: across both levels as follows:
- The total expense ratio (TER) for FoFs investing in liquid schemes, index funds, and ETFs is capped at 1%
- The TER for FoFs investing in equity-oriented schemes is capped at 2.25%
- The TER for FoFs investing in schemes other than those mentioned above is capped at 2%
International Fund
International funds allow investors to invest in markets outside India. They may hold one or more of the following in their portfolio:
- Equity of companies listed abroad.
- Debt of companies listed abroad.
- ETFs from other countries.
- Units of passive index funds from other countries.
- Units of actively managed mutual funds from other countries.
- International equity funds may also hold some of their portfolios in Indian equity or debt.
- They can also hold a portion of the portfolio in money market instruments to manage liquidity.
International funds offer investors additional benefits such as:
- Diversification, as global markets may have low correlation with domestic markets
- Access to investment options that may not be available in India
- Exposure to companies that are global leaders in their industries
Consider the risks asociated with investing in such funds, such as:
- Political events and macroeconomic factors that may be less familiar and harder to understand
- Movements in foreign exchange rates, which can affect returns at the time of redemption
- Changes in investment policies by countries toward global investors
Quick Summary
- Large cap funds: Lower risk compared to other equity categories. Expected returns of around 11–13% CAGR. Ideal for beginners looking to build long-term wealth.
- Mid cap funds: Higher risk compared to large-cap funds. Expected returns of around 12–15% CAGR. Suitable for long-term wealth building.
- Small cap funds: Very high risk. Expected returns of around 15–18% CAGR. Suitable for investors willing to take higher risk.
- Debt funds: Low risk. Expected returns of around 5–8%. Best suited for short-term goals.
- Hybrid funds: Moderate to high risk. Expected returns of around 8–12%. Ideal for investors looking for a balanced approach through asset allocation.
- Index funds: Less volatile compared to mid-cap and small-cap funds. Returns are usually similar to indices like the Nifty or Sensex. Suitable for passive investors.
- ELSS funds: Similar risk profile to equity funds. Expected returns of around 11–15%. Ideal for investors looking for tax savings.
Note: Returns mentioned above are based on historical data and are not guaranteed or predictive of future performances.
Final Thoughts
You cannot point to a single mutual fund and call it the best. The best fund depends on your goals, investment horizon, and risk appetite.
Mutual funds make investing simple — you don’t need to pick individual stocks, analyze the market, or time your investments. You just choose the right type of fund, stay consistent, and let compounding work for you.
If your goal is long term wealth creation, understanding fund categories is only the beginning. We have covered the complete approach, including how to start investing and how to stay invested in my article on How to Build a Long Term Wealth Through Mutual Funds.
Disclaimer: Investing in securities market, mutual funds and securitized debt instruments are subject to market risk. Please read all scheme related documents carefully before investing.
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