Useful, simple to understand and easy to execute. Those should be the qualities that your first fund investments should have.
For beginners, these requirements are generally best satisfied by tax-saving funds (if needed) or aggressive hybrid funds. Here's why. When you start investing in mutual funds, it makes sense to invest in a fund that invests mostly in equity. The reason for this is that you are likely to have no equity investments at all. Investors at an early stage of their investing life generally have bank deposits, PPF and other fixed-income investments. Since equity is the best form of long-term investment, and mutual funds the easiest and safest way to invest in equity, it follows that the type of fund you choose must be an equity fund. There are two types of funds that are uniquely suitable as beginners' funds. These are Tax-Saving Funds and Aggressive Hybrid Funds.
Tax Savings Funds: Tax saving funds are also called ELSS funds as their formal name in the tax law is Equity-Linked Savings Scheme. They are basically all-equity funds, investments in which are eligible for tax exemptions under Section 80C of the Income Tax Act. Under Section 80C, you can invest up to Rs 1.5 lakh in a set of investments, one of which is ELSS funds. Since they are equity funds, one should invest in them for long-term. This long-term imperative is compulsorily enforced because under the tax laws, investments made into these funds are locked in for at least three years. Because of this lock-in, investors tend to have a good experience of getting reasonable returns from these funds. Moreover, the tax-break acts as a natural boost to returns.
Aggressive Hybrid Funds: Aggressive hybrid funds combine equity and debt investments in a certain ratio. In order to maintain this ratio, the fund manager will typically disinvest from holdings that have gained more and invest in holdings that have gained less. This, of course, is asset rebalancing.
Effectively, the gains that are made in equity are protected by debt. The great advantage of aggressive hybrid funds is that they can have up to 35 per cent debt and this controls volatility to some extent. They gain well when the markets gain but when the markets fall, they fall less sharply, thus protecting the gains that were made in the good times.