Types of Mutual Funds

The previous article explained what mutual funds are, how NAV works, and how to buy your first one. But when you open Groww or Kuvera and search for funds, you’ll see categories like “Large Cap”, “Flexi Cap”, “Short Duration Debt”, “Aggressive Hybrid” and wonder what any of it means.

There are over 40 SEBI-defined mutual fund categories. You don’t need to know all of them. Most people need two or three types at most. This article covers every category worth knowing about, and tells you which ones to ignore. Broadly, mutual funds can be categorized into three types:

  • Equity: invests in stocks
  • Debt: lends your money to companies or government for fixed interest (like an FD, but better)
  • Hybrid: mix of equity and debt

Equity funds

Equity funds invest your money in stocks. They carry higher risk than debt funds, but over long periods (7+ years), they deliver the best returns. If you’re investing for retirement, your child’s education, or any goal more than 7 years away, equity funds are where most of your money should go.

Broadly, equity funds are divided based on the size of companies they invest in. SEBI defines this ranking by total market value (how much the company is worth on the stock exchange) across BSE and NSE:

  • Large-cap: top 100 companies by market value
  • Mid-cap: companies ranked 101-250
  • Small-cap: companies ranked 251 and below

Large-cap funds

These invest in the top 100 companies by market value. Reliance, TCS, Infosys, HDFC Bank, the names you already know.

  • Expected returns: Historically around 10-12% per year over 10+ years, but returns can vary significantly depending on market conditions
  • Risk: Moderate. They drop in crashes, but recover faster than smaller companies
  • Minimum horizon: 5-7 years
  • Pick this if: You want steady equity growth without wild swings

Large-cap funds are the most stable equity category. They won’t double your money in one year, and they tend to fall less than mid and small caps, but can still see significant declines in severe market crashes. Good starting point if index funds feel too basic and you want an actively managed option.

Mid-cap funds

These invest in companies ranked 101-250 by market value. Established businesses that are still growing, including mid-sized listed companies across sectors.

  • Expected returns: Historically around 12-15% per year over 10+ years, though returns can vary widely across cycles
  • Risk: High. Can drop 25-35% in a bad year
  • Minimum horizon: 7-10 years
  • Pick this if: You have a long horizon and can stomach seeing your portfolio drop 30% without panicking

Mid-caps are where you get the real growth. Many of today’s large-caps were mid-caps 10 years ago. But the ups and downs are real. If a 30% drop on your portfolio screen would make you sell, stick to large-cap or flexi-cap.

Small-cap funds

These invest in companies ranked 251 and below. Smaller, newer, less proven businesses.

  • Expected returns: Historically around 15-18% per year over 10+ years, but wildly inconsistent and highly dependent on market cycles
  • Risk: Very high. Can drop 40-50% in a bad year. Some small companies simply fail
  • Minimum horizon: 10+ years
  • Pick this if: You’re young, have a very long horizon, and this is a small portion (10-20%) of your total portfolio

Small-cap funds are high-reward but high-pain. In 2018-19 and again in 2022, many small-cap funds lost 30-40%. The ones who held through came out well. The ones who panicked and sold locked in their losses.

Never put money here that you might need in the next 10 years. And never put all your money here. If you’re considering a small-cap fund, check the fund’s stress test data on its factsheet. It shows how quickly the fund manager can sell holdings in a crash.

There are more equity fund categories beyond large, mid, and small-cap. Index funds (article coming soon) deserve their own deep dive since they’ve become the default recommendation for most investors. And SEBI has defined several strategy-based categories like flexi-cap, multi-cap, ELSS, and others, covered in Equity Fund Categories Beyond Large, Mid, and Small-Cap.

Debt funds

Debt funds lend your money to companies or the government, and earn fixed interest in return. Think of it like an FD, but instead of lending to a bank, the fund lends to multiple borrowers. Lower returns than equity, but much more predictable. Use them for money you’ll need in 1-3 years, or as the stable part of your portfolio.

If you want to understand how bonds and lending works in more detail, read What are bonds and fixed income? (coming soon)

Broadly, debt funds are categorized by what they lend to and for how long:

  • Liquid funds: lends for very short periods (under 91 days), like a smarter savings account
  • Short-duration funds: lends for 1-3 years
  • Gilt funds: lends only to the government, zero risk of not getting paid back but returns fluctuate with interest rates

Since April 2023, debt fund gains are taxed at your income tax slab rate regardless of holding period. This reduced their tax advantage over FDs, but they still offer better liquidity and sometimes better post-tax returns.

One risk to watch across all debt funds: credit risk. Some debt funds invest in lower-rated bonds to generate higher returns. Stick to high-quality or short-duration funds unless you understand this risk. Expense ratio matters across all fund types: even a 1% difference compounds significantly over long periods.

Liquid funds

Think of these as a smarter savings account. They lend your money for very short periods (under 91 days) and give it back almost instantly when you need it.

  • Expected returns: 5-6% per year
  • Risk: Very low, though not completely risk-free
  • Withdrawal: Usually within 1 working day (some offer instant redemption up to ₹50,000)
  • Pick this if: You have idle cash sitting in savings that you don’t need immediately but might need in a few days or weeks

If you have ₹3 lakh in your savings account earning 3-4%, move ₹2 lakh to a liquid fund and earn 5-6% while keeping it almost as accessible.

Short-duration funds

These lend your money for 1-3 years. Slightly higher returns than liquid funds because the fund lends for longer periods.

  • Expected returns: 6-7% per year
  • Risk: Low. Some fluctuation when interest rates change, but minor
  • Minimum horizon: 1-2 years
  • Pick this if: You’re saving for something 1-3 years away. A car, a vacation, a wedding down payment

Gilt funds

These lend only to the government. Zero chance of not getting your money back because the government won’t default on its own debt.

  • Expected returns: 6-8% per year
  • Risk: Low credit risk, but prices fluctuate with interest rates. Long-duration gilt funds can be volatile despite zero credit risk
  • Pick this if: You want the safest possible debt investment and have a 2-3 year horizon

Gilt funds react strongly to interest rate changes. When RBI cuts rates, gilt fund prices go up. When rates rise, prices fall. If this sounds confusing, we have a detailed article on how interest rates affect your money (coming soon). If you don’t want to think about rate cycles, stick to short-duration or liquid funds.

Hybrid funds

These mix equity and debt in one fund. Useful if you want equity exposure but aren’t comfortable going 100% stocks.

Broadly, hybrid funds differ by how much they put in equity vs debt:

  • Aggressive hybrid: mostly equity (65-80%), some debt for cushioning
  • Balanced advantage: automatically shifts between equity and debt based on how expensive the market is

Aggressive hybrid funds

Invest 65-80% in equity and 20-35% in debt. Because equity is above 65%, they’re taxed like equity funds (which is better for you).

  • Expected returns: Historically around 10-12% per year over 7+ years
  • Risk: Moderate. Since part of the fund is in debt, your losses are smaller when markets fall
  • Pick this if: You want equity-like returns with slightly less volatility, and you prefer one fund over maintaining separate equity and debt funds

Balanced advantage funds / Dynamic funds

These automatically shift between equity and debt based on market conditions. When markets are expensive, they move more to debt. When markets are cheap, they increase equity. The fund does the rebalancing so you don’t have to.

  • Expected returns: Historically around 9-11% per year over 5+ years
  • Risk: Moderate. The automatic rebalancing helps
  • Pick this if: You want a single fund that manages the equity-debt mix for you. Good for people who tend to panic in crashes

Others worth knowing

International funds: Invest in stocks outside India (US, China, global). Good for diversification, but the rupee-dollar movement affects your returns and fees are higher. Consider allocating 10-15% of your portfolio here once your domestic investments are sorted. Note: Many international funds frequently pause fresh investments due to RBI’s industry-wide limit. Check if the fund is accepting SIPs or lump sum before you invest.

Gold funds/ETFs: Track gold prices. An alternative to buying physical gold. Useful as 5-10% of your portfolio for diversification. No making charges, no storage worries, no purity concerns. If you want to know more about gold investing, a detailed article is coming soon.

Fund of Funds (FoF): A mutual fund that invests in other mutual funds. You end up paying fees twice (the FoF’s fees plus the underlying fund’s fees). Mostly avoidable unless it’s the only way to access a specific strategy. If you want to know more, a detailed article is coming soon.

Most people need just 2-3 fund types: a Nifty 50 index fund for equity, a liquid or short-duration fund for short-term money, and optionally a flexi-cap if you want active management. Don't collect categories. Keep it simple.

What’s next?

Want to know more about flexi-cap, multi-cap, ELSS, and other equity categories? Read Equity Fund Categories Beyond Large, Mid, and Small-Cap.