Mutual funds are broadly classified into equity funds, debt funds, and balanced fundsOne of the most popular investment options, mutual funds are formed when an asset management company or fund house decides to pool investments from several individuals and institutional investors with a common investment objective. They then appoint a fund manager, who is a finance professional, to manage the pooled investment and make the purchases such as stocks and bonds. Investing in mutual funds helps an individual get exposure to an expert-managed portfolio. Since the allocation of fund units is based on investment, profits and losses are also directly proportional to that amount.Mutual funds are broadly classified into equity funds, debt funds, and balanced mutual funds, depending on their asset allocation and exposure. Let’s see what significance each of them holds.Equity fundsEquity funds invest in equity shares of companies. A mutual fund is categorised under equity funds if it invests at least 65% of its portfolio in equity instruments. These funds can offer the highest returns among all classes of mutual funds. The returns, however, depend on the market movements, which are influenced by several geopolitical and economic factors. Equity funds are further classified into several groups depending on the market capitalisation of companies and sector of operation.Debt mutual fundsDebt mutual funds invest mostly in debt, money market, and other fixed-income instruments such as treasury bills, government bonds and certificates of deposit. For a mutual fund to classify as a debt fund it has to invest a minimum of 65% of its portfolio in debt securities. Debt funds are a good investment option for those who are averse to risk as the performance of debt funds is not dependent much on market fluctuations. Therefore, the returns are predictable.Balanced or hybrid mutual fundsThese funds invest across both equity and debt instruments. Their main objective is to balance the risk-reward ratio. Depending on the market condition, the fund manager can modify the asset allocation to benefit the investors and reduce the risk levels. Investing in hybrid funds diversifies your portfolio to gain exposure to both equity and debt instruments.