A Beginner’s Guide to Investing in Equity Mutual Funds - Part 1

Many young investors who are just starting their investment journey often feel confused about how and where to begin investing in mutual funds. As part of a 3-part blog series, I’ll simplify this journey step by step:

• Part 1: Various types of Mutual Funds

• Part 2: Scheme variants within Mutual Funds (Dividend/Growth, Regular/Direct)

• Part 3: Where and how to invest in Mutual Funds

Part 1: Various Types of Equity Mutual Funds

1. Large-Cap Mutual Funds

Large-cap funds invest at least 80% of their assets in the top 100 companies by market capitalization listed on Indian stock exchanges. Since these companies are well-established and financially stable, large-cap funds are considered the least risky among pure equity funds. They are an ideal starting point for young and first-time investors to begin their equity investment journey.

2. Mid-Cap Mutual Funds

Mid-cap funds invest in companies ranked 101 to 250 by market capitalization. These companies have higher growth potential but are more volatile than large-cap companies.

• Young investors may consider allocating 10–25% of their portfolio to mid-caps only if:

  • They have a long investment horizon (6–7 years or more)

  • They can tolerate periods of negative returns

  • They have a high savings rate

  • They invest only through SIPs, not lump sum

3. Small-Cap Mutual Funds

Small-cap funds invest in companies ranked 251 to 500 by market capitalization. These funds are highly volatile and risky. While they may deliver higher returns during market upcycles, the volatility can be extreme.

• Young and new investors are better off avoiding small-cap funds, especially at the start of their investment journey.

4. Flexi-Cap Mutual Funds

Flexi-cap funds can invest across large-cap, mid-cap, and small-cap stocks without any fixed allocation limits. This flexibility allows the fund manager to adjust exposure based on market conditions.

• Suitable for investors who want diversification beyond large caps without taking excessive risk.

5. Multi-Cap Mutual Funds

Multi-cap funds are required to invest at least 25% each in large-cap, mid-cap, and small-cap stocks. The remaining 25% can be allocated at the fund manager’s discretion.

• For young and new investors, flexi-cap funds are generally better than multi-cap funds, as risk can be managed more effectively.

6. Aggressive Hybrid Mutual Funds

These funds invest 65–80% in equity and the remaining portion in debt instruments. The debt component helps reduce volatility compared to pure equity funds.

• A good option for risk-averse investors

• Young investors with a time horizon of more than 5 years are better off with pure equity funds

7. Dynamic Asset Allocation Funds

These funds also invest in both equity and debt, but unlike hybrid funds, they do not have a fixed allocation. The fund manager dynamically changes exposure based on market conditions.

• Suitable for conservative investors

• Young investors should prefer pure equity funds for long-term wealth creation

8. Sector / Thematic Funds

These funds invest in a specific sector (e.g., infrastructure, FMCG, banking) or follow a particular theme (e.g., exports, MNCs). They are highly cyclical and can experience long periods of underperformance.

• Best avoided by young and first-time investors.

9. Focused Funds

Focused funds invest in a concentrated portfolio of up to 30 stocks, compared to 50–100 stocks in diversified funds. Due to this concentration, returns depend heavily on fund manager expertise, making these funds volatile.

• Not recommended for new investors.

10. Index Funds

Index funds are low-cost passive funds that track a market index such as the Nifty 50, Nifty 100, or Nifty Midcap 150. As markets mature, it becomes increasingly difficult for active fund managers to consistently beat the index. Index funds also eliminate the need to constantly track fund performance.

• Excellent choice for young and new investors to begin investing.

Conclusion

For young investors just starting out:

• Stick to index funds and large-cap funds

• With a long time horizon, consider flexi-cap funds or a small allocation to mid-caps

• Avoid small-cap, sectoral, thematic, and focused funds

A simple, disciplined approach works best in the long run.