Equity mutual funds are designed to help you achieve long-term financial goals by investing primarily in equity shares of various companies. However, they are best suited for investors with a higher risk tolerance, as the value of equity investments can fluctuate widely based on market conditions. Keep reading to know more!
What are Equity Mutual Funds?
Equity mutual funds are investment vehicles that primarily invest in stocks to generate long-term capital appreciation. By pooling money from multiple investors, these funds allow investors to invest in a diversified portfolio of shares from various companies.
Key Features of Equity Mutual Funds
Now, letтАЩs look at some of the key features of equity mutual funds:
Returns
Equity mutual funds offer a higher potential for returns than other types of investments. However, this comes with increased volatility, meaning the value of your investment can fluctuate majorly in the short term.
Risk
Investing in equity funds carries higher risk due to market fluctuations. This risk-reward trade-off means you could see substantial gains but also face the possibility of losses.
Tax Benefits
Some equity mutual funds, like Equity Linked Savings Schemes (ELSS), provide tax deductions as part of India’s Section 80C of the Income Tax (I-T) Act. Investing in these schemes helps you save on taxes while potentially growing your wealth.
Expense Ratio
The expense ratio refers to the costs associated with managing a mutual fund. Equity funds typically have higher management costs due to the active management involved in stock selection and monitoring.
Long-Term Investment
Historically, stocks have shown the ability to grow over time, making these funds a fitting choice for building wealth over the long haul.
Types of Equity Mutual Funds
Here’s a breakdown of the different types of equity mutual funds:
Based on Market Capitalization
Market capitalisation is defined as the total market value of a company’s outstanding shares. This classification typically includes:
Large-Cap Equity Funds
These funds invest in the most prominent companies, typically the top 100 by market capitalisation. They provide stability and are considered less risky than smaller funds.
Mid-Cap Equity Funds
Mid-cap funds focus on companies ranked 101 to 250 by market capitalisation. These companies have more growth potential but also higher volatility.
Small-Cap Equity Funds
Small-cap funds invest in smaller companies with a market capitalisation below тВ╣5,000 crore. These stocks offer the highest growth potential but come with significant risk.
Multi-Cap Equity Funds
Multi-cap funds invest in large, mid, and small-cap stocks, providing diversification and a balanced risk profile.
Based on Investment Strategy
Investment strategies define how funds approach their investment decisions. The different types of equity funds under this category are:
Thematic or Sectoral Funds
These funds focus on particular sectors, such as technology or healthcare. They offer targeted exposure but carry higher risk due to their narrow focus.
Focused Equity Funds
These funds invest in a limited amount of stocks, usually around 30. This concentrated approach allows for deeper research and attention to each investment.
Contra Equity Funds
These follow a contrarian strategy, buying undervalued stocks with the expectation of future recovery.
Value-Oriented Equity Funds
Value funds invest in undervalued stocks that are expected to appreciate over time.
International Equity Funds
These funds invest in stocks from global markets, providing investors with international exposure.
Based on Tax Treatment
Funds are also distinguished by their tax treatment, impacting the investor’s overall returns. These include:
Equity Linked Savings Scheme (ELSS)
ELSS funds invest at least 80% in equities and have tax benefits under Section 80C of the Income Tax Act, with a lock-in period of three years.
Non-Tax Saving Equity Funds
These are standard equity funds without tax benefitsтАФsubject to capital gains tax upon withdrawal.
Based on Investment Style
Investment styles categorise funds based on their approach to selecting securities. Some of these funds are:
Active Equity Funds
Financial experts actively manage these funds by selecting stocks based on in-depth research.
Passive Equity Funds
These funds track market indices and have lower management costs, with no active stock selection.
Index Funds
Index funds focus on replicating the performance of specific market indices like Nifty or Sensex.
How Do Equity Mutual Funds Work?
HereтАЩs a breakdown of how equity mutual funds work, including how fund managers handle your investments:
- Pooling Investments: Equity mutual funds pool money from various investors to build a diversified portfolio of equity stocks.
- Stock Selection and Portfolio Management: Fund managers select stocks based on their research and market analysis, focusing on either growth (companies expected to grow faster than the market) or value (companies deemed undervalued) strategies.
- Diversification: By spreading investments across various stocks and sectors, equity mutual funds help lower the impact of a single stock’s poor performance on your overall investment.
- NAV Fluctuations: The fund’s Net Asset Value (NAV) reflects the total value of all its assets minus any liabilities. This value fluctuates based on the performance of the underlying stocks.
Benefits of Investing in Equity Mutual Funds
HereтАЩs why equity mutual funds stand out as a strong investment option:
Diversification
Equity mutual funds invest in multiple stocks across different sectors and market capitalisations (the total market value of a company’s outstanding shares). This reduces the impact of a single stock’s poor performance on your portfolio.
Potential for High Returns
Equity mutual funds usually give higher returns than other asset classes like debt and fixed income. However, they come with higher volatility (the degree of variation in a financial instrumentтАЩs price).
Professional Management
Experienced fund managers conduct detailed research and analysis to make informed investment decisions, saving time and effort.
Risks Associated with Equity Mutual Funds
HereтАЩs a look at the key risks you should be aware of.
Market Risk
Equity mutual funds are subject to market riskтАФtheir value fluctuates based on overall market conditions. Fund values may rise when the market is strong, but they can drop significantly in downturns.
Volatility
Equity markets are inherently volatile, meaning prices can change rapidly in response to news, economic reports, or other events. Such fluctuations can impact the value of your equity mutual funds, leading to potential losses in the short term.
Liquidity Risk
Liquidity risk occurs when you may not be able to sell your equity mutual fund shares quickly or at a fair price during extreme market conditions. This risk is particularly prevalent in small-cap funds, which invest in smaller companies and may not have as many buyers.
How to Choose the Best Equity Mutual Fund
Below is a step-by-step guide to help you make informed decisions.
Analyse Risk Appetite
Before diving into equity mutual funds, you must assess how much risk you are comfortable taking. HereтАЩs a quick breakdown:
- Large-cap funds Invest in large, established companies and are generally considered safer. They offer moderate returns and are ideal for conservative investors.
- Mid-cap funds: Provides a balance between risk and return. Suitable for investors with moderate risk tolerance.
- Small-cap funds Invest in smaller companies with higher growth potential but more risk. They are best suited for those with a high-risk appetite.
Assess Investment Horizon
Equity mutual funds perform best over the long term. They are ideal for investors who can commit to them for at least 5 to 7 years.
For instance:
- Short-term goals (1-3 years): Avoid equity funds and consider debt funds for lower risk.
- Long-term goals (5+ years): Equity funds are better suited as they can generate higher returns over time.
Fund Performance Evaluation
Past performance is not a guarantee of future returns; when evaluating a fund, focus on these factors:
- Look for funds that have performed consistently over multiple market cycles.
- A fund manager with a proven track record can be an important factor in the fundтАЩs success.
- Compare the fundтАЩs returns against its benchmark to assess whether it has outperformed the market.
Consider Expense Ratio
The expense ratio refers to the annual fee the mutual fund charges for managing your investment. A lower expense ratio means more money stays invested, leading to higher net returns.
How to Invest in Equity Mutual Funds?
Getting started with equity mutual funds is simple, especially with platforms like Appreciate. Here’s a step-by-step guide to help you begin:
- Open an Appreciate Account: Download the app and sign up. ItтАЩs quick, and youтАЩre ready to explore the available funds.
- Choose Your Fund: Appreciate offers a wide range of equity mutual funds, ensuring you can pick one that aligns with your financial goals.
- Invest and Track: Once you’ve selected your fund, make the payment through the app. AppreciateтАЩs smart portfolio tracker helps you monitor your investments in real time.
- Benefit from Zero Fees: Enjoy zero commissions and account opening fees on direct mutual funds, ensuring more of your money works for you.
- Get Personalised Recommendations: AppreciateтАЩs AI-driven recommendations make investing in funds that best suit your risk profile and goals easy.
Direct Plans vs Regular Plans
You can decide between direct and regular plans when investing in mutual funds. Here’s how they differ:
Feature |
Direct Plans |
Regular Plans |
Investment Path |
Invest directly with the fund house |
Invest through intermediaries (advisors, banks) |
Cost |
Lower expense ratio (no commission involved) |
Higher expense ratio (includes commissions) |
Returns |
Higher due to lower costs |
Slightly lower due to intermediary fees |
Financial Guidance |
No advisor involvement; manage on your own |
Advisors assist in decision-making |
Lump Sum vs SIP
You can either choose a lump sum or a Systematic Investment Plan (SIP) when investing in mutual funds. Below is a comparison:
Criteria |
SIP |
Lump Sum |
Investment Amount |
Fixed amounts at regular intervals |
One-time large investment |
Market Timing |
Averages out market fluctuations |
Subject to market volatility |
Cost Averaging |
Benefits from cost averaging over time |
No cost averaging, fully exposed to market changes |
Flexibility |
More flexible, start with small amounts |
Requires a larger amount upfront |
Time Horizon |
Suitable for long-term goals |
Better for short-term goals |
Taxation of Equity Mutual Funds
Gains from equity mutual funds are categorised into:
Short-Term Capital Gains (STCG)
If you sell your fund units within one year, the gains are classified as short-term and taxed at 15%. This tax applies regardless of your income bracket.
Long-Term Capital Gains (LTCG)
If you hold your units for over a year, any gains up to тВ╣1 lakh are tax-free. However, if your gains exceed тВ╣1 lakh, they are taxed at 10% without indexation (adjustment for inflation).
The Bottom Line
Investing in equity funds is an excellent way to build long-term wealth. These funds invest in stocks and offer higher returns than traditional options, though they come with some risk. The key is to decide on the right fund according to your financial objectives and risk tolerance.┬а
Moreover, at Appreciate, we make it easy for you to find the best mutual fund for your needs. You can start investing confidently with personalised recommendations, zero commissions, and easy portfolio tracking. Download the app now!
Equity Mutual Funds FAQs
What are equity mutual funds, and how do they work?
Equity funds invest significantly in stocks, aiming for capital appreciation over the long term. Fund managers select and manage a portfolio of shares to meet the fundтАЩs investment objectives.
What are the different types of equity mutual funds?
The main types include large-cap, mid-cap, small-cap, multi-cap, and sectoral funds. Each focuses on different stock market segments and offers varying risk and return potential.
How can I choose the best equity mutual fund for my portfolio?
Consider your financial aims, risk tolerance, and investment horizon. Also, the fund’s historical performance, expense ratio, and the reputation of the fund manager should be analysed before deciding.
What are the benefits of investing in equity mutual funds?
Equity mutual funds offer professional management, diversification, and the potential for higher returns than traditional savings options. They are also easy to access and require lower initial investments.
What are the risks associated with equity mutual funds?
These funds carry market risk, meaning returns can fluctuate based on stock market performance. Additionally, there’s a chance of capital loss, especially with high-risk funds like small-cap.
How are equity mutual funds taxed in India?
Long-term capital gains (LTCG) over тВ╣1 lakh are taxed 10%, while short-term capital gains (STCG) are taxed 15%. Dividends from equity mutual funds are also taxable to the investor.
What is the minimum investment required for equity mutual funds?
The minimum investment varies across funds but usually starts as low as тВ╣500 for SIPs (Systematic Investment Plans). Depending on the fund, lump sum investments may require a higher minimum amount.
Can I invest in equity mutual funds with a short-term investment horizon?
While equity mutual funds are typically suited for long-term goals, certain funds, such as sectoral or small-cap funds, can be chosen for short-term growth. However, short-term investments are riskier.
How do expense ratios affect returns in equity mutual funds?
Expense ratios represent the fund’s management and operational costs. Higher expense ratios can reduce net returns, so it is essential to choose funds with competitive costs.
Are SIPs better than lump sum investments in equity mutual funds?
SIPs allow you to invest regularly, averaging market fluctuations and minimising risk. Lump sum investments may offer higher returns if timed well but have greater market timing risk.
What is the difference between large-cap and small-cap equity mutual funds?
Large-cap funds invest in established, stable companies with a larger market capitalisation, offering lower risk but moderate returns. In contrast, small-cap funds target smaller companies with higher growth potential but greater risk.
How do I start investing in equity mutual funds?
You can use the Appreciate app to begin investing in equity mutual funds. Simply open an account, select a fund based on your goals, and start investing via SIP or a one-time lump sum payment
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