Mutual funds combine fund management expertise, reduction of volatility and lower costs to give returns to investors. While some investors use mutual funds for a regular source of income, there is a large number of investors who invest in mutual funds for creating wealth.

Here are some basics about which types of mutual funds could be used for building a large corpus over the long run:

 
Debt funds

In India, investments in debt funds usually enjoy indexation benefits, which in other terms is the government's way of compensating an investor from the loss that accrues to his/her investments in debt funds because of inflation in the country. This is one of the advantages for debt funds that helps investors build we a l t h t h ro u g h t h e s e schemes because, to build wealth, one needs to grow money over the long term and the same should beat the rate of inflation over that period of time.

Within debt funds, there are various types: Liquid funds, long-, medium- and short-term bond funds, gilt funds, fixed maturity plans, etc. Of these, liquid funds are the ones in which you can keep your money if your investment horizon is from a few days to, say, about six months. These are usually used to park your money for the short term. These are not the funds that one can use to build long-term wealth. Compared to liquid funds, returns from other types of debt funds are usually higher.

Equity funds

Equity funds invest most of their corpus in stocks. These are more risky schemes than debt funds and usually also show a higher level of volatility. But financial planners and advisers always bank on equity funds for long-term wealth creation. This is mainly because, going by historical data, stocks have always given returns that have beaten the rate of inflation in the long run. So when it comes to building wealth, equity funds are the preferred investment vehicles compared to debt funds.

In India, all equity funds also enjoy exemptions from long-term capital gains tax, which make these funds even more eligible to grow one's wealth. Financial planners and advisers say that if investors have the risk appetite and have time on their side, then they should always opt for equity funds over debt funds for wealth creation.

Within equity funds, there are various types of schemes:

Diversified , large-, mid- and smallcaps, equity-linked savings schemes (ELSS), sectoral funds, etc.

Of these, large-cap schemes usually show less volatility than mid- and small-cap funds as they are more risky than large-cap ones.

For wealth creation, going by the risk-taking ability of each investor, financial planners and advisers suggest a portfolio of funds that is usually a mix of diversified, large-, mid- and smallcap schemes.
An ELSS is often mixed with other types of schemes to give some extra tax advantage since these funds are approved by the government for tax rebates under certain conditions.

On the other hand, sectoral funds — which invest in a particular sector like IT, FMCG, banking, etc — are never used for long-term wealth creation. This is because a particular sector never shows a secular upward movement but displays a more cyclical nature.

Other types

There are some other types of funds also, like monthly income schemes (MIS), which are mainly used for generating regular income. And then there are balanced funds. Although, ideally, these should have equity and debt in equal ratio, most balanced funds have at least 65% equity to take advantage of income tax rules. They are more volatile and risky than they should be, and are not the ideal vehicles for building wealth.