Equity funds are a category of mutual funds that primarily invest in stocks of various companies listed on the stock exchange. These funds pool money from multiple investors with the objective of seeking a relatively better return potential by participating in the stock market. Additionally, equity funds offer an opportunity for individuals to indirectly invest in a diversified portfolio of stocks, even with a modest amount of capital.
Table of contents
- What is an equity fund?
- What are the benefits of investing in equity funds?
- How do equity funds work
- Types of equity funds:
- Taxation Rules of Equity Mutual Funds
- Role of equity in long-term wealth creation
- Why do many people choose equity mutual funds?
- When is the right time to invest in equity mutual funds?
- Why should you invest long term in Mutual funds?
- Mistakes to avoid when investing in equity funds
- How to invest in equity funds?
What is an equity fund?
An equity fund is a type of mutual fund that invests predominantly in shares of listed companies. The performance of the fund is linked to the price movements of the underlying stocks in its portfolio. These funds are managed by professional fund managers, who select stocks based on the fund’s stated investment objective and strategy.
Equity funds may follow different approaches, such as focusing on large cap, mid cap or small cap companies, specific sectors or themes, or adopting a diversified multi cap strategy. While they offer the potential to participate in long term wealth creation through equity markets, they are also subject to market volatility and may experience fluctuations in value over shorter time horizons.
What are the benefits of investing in equity funds?
- Professional management: Equity funds are managed by expert fund managers who make investment decisions on behalf of investors.
- Diversification: Investing in a variety of stocks reduces risk since under performance in one stock/sector may be offset by others.
- Liquidity: Investors can sell open-ended equity fund units on any business day at the prevailing NAV (Net Asset Value).
- Potential for growth: Equity funds offer the potential for capital appreciation over the long term.
- Affordability: Even with a modest initial investment, individuals can access a diversified portfolio of stocks through equity funds.
How do equity funds work
Equity mutual funds pool money from multiple investors and allocate a majority of their assets to equities. Here’s how they work:
- Pooling of money: Investors contribute funds which are collectively managed by professional fund managers.
- Investment in equities: The fund manager invests in stocks in one or many sectors and market capitalisations such as large cap, mid cap, or small cap, depending on the fund’s mandate.
- NAV calculation: The Net Asset Value (NAV) represents the per-unit value of the fund and fluctuates based on market movements.
- Returns: Equity funds may provide potential capital appreciation over time as the value of underlying stocks changes. IDCW (Income Distribution cum Capital Withdrawal) options may also be available for those seeking periodic payouts.
- Risk factors: Market volatility, economic conditions, and company performance can influence returns.
Types of equity funds:
Equity funds come with several flavours, each with its unique characteristics and investment strategies. Here’s a breakdown of some of the types of equity funds:
Large cap equity funds:
Covers top 100 companies in terms of market capitalization.
These funds predominantly invest in stocks of well-established and large companies.
They are known for stability and relatively lower risk due to the size and reputation of the companies in the portfolio.
Mid cap equity funds:
Covers 101-250 companies in terms of market capitalization.
These funds focus on stocks of medium-sized companies.
They offer a balance between growth potential and risk, making them suitable for investors with moderate risk tolerance.
Small cap equity funds:
Covers companies beyond 250 in terms of market capitalization.
Small-cap funds primarily invest in stocks of smaller, emerging companies.
They have the potential for high growth but are also associated with higher volatility.
Suited for investors with a higher risk appetite and a long-term investment horizon.
Sectoral/thematic equity funds
These funds concentrate their investments in specific sectors or themes, such as technology, healthcare, or bank, among others.
They allow investors to potentially capitalise on the growth prospects of a particular industry.
Risk varies depending on the specific sector’s performance and market situation.
Dividend yield equity funds
These funds focus on stocks of companies with a history of paying dividends.
They aim to provide a regular income stream in the form of dividends in addition to potential capital appreciation.
Multi cap equity funds
Multi-cap funds have the flexibility to invest across large, mid, and small-cap stocks.
In multi cap large cap, mid cap and small cap are compulsorily allocated 25%.
Investing in equity funds offer a gateway to the world of stocks for investors looking to build wealth over time. However, it’s crucial to remember they also carry market-related risks. Therefore, it’s advisable to consult a financial advisor before making investment decisions to align your choices with your financial goals and risk tolerance.
Taxation Rules of Equity Mutual Funds
The tax treatment depends on the holding period:
- Short term capital gains (STCG): If units are sold within 12 months from the date of allotment, gains are classified as short term capital gains. These gains are taxed at 20% (plus applicable surcharge and cess).
- Long term capital gains (LTCG): If units are held for more than 12 months, gains are treated as long term capital gains. LTCG exceeding ₹1.25 lakh in a financial year is taxed at 12.5% (plus applicable surcharge and cess). Gains up to ₹1.25 lakh remain exempt in a financial year.
- IDCW payout taxation: Income Distribution cum Capital Withdrawal (IDCW) payouts are added to the investor’s total income and taxed according to the applicable income tax slab rate. Tax Deducted at Source (TDS) may apply as per prevailing rules.
Role of equity in long-term wealth creation
An equity portfolio is a collection of stocks and shares. You can invest in equities either directly through the stock market, or through equity mutual funds. When you invest in equities, you essentially purchase shares of publicly listed companies. Investors make money if these shares increase in value over time.
Equity investments can aid wealth creation because of their superior return potential in the long term when compared to debt securities and other traditional savings avenues.
Factors to consider before investing in equity funds
When transitioning from liquid funds to equity funds, investors should keep the following in mind:
- Risk tolerance: Equities are riskier compared to liquid funds. Understand your risk tolerance before investing. If you are uncomfortable with high risk, consider allocating a smaller portion of your liquid fund gains to equities.
- Investment horizon: Equities are suitable for long-term investments. Ensure that you do not need the money in the short term. A longer investment horizon helps you ride out market volatility.
- Market conditions: While timing the market is not recommended, be aware of current market conditions. Avoid investing a large sum during a market peak. Consider averaging out your investments over time through an STP or an SIP.
- Financial goals: Align your equity investments with your financial goals. If you have short-term goals, keep some funds in relatively stable investments like liquid funds.
- Liquidity needs: Ensure you have enough liquidity for emergencies. Do not invest all your liquid fund gains into equities. Keep a portion in liquid funds for easy access.
Why do many people choose equity mutual funds?
Diversification made easy
As they say: “Don’t put all your eggs in one basket.” Equity mutual funds allow investors to achieve diversification effortlessly. Instead of concentrating their funds on a handful of stocks, investors’ money is spread across various sectors and companies.
Professional expertise
Many investors lack the resources to conduct thorough analyses of companies and market trends. Equity mutual funds eliminate this barrier by entrusting fund managers with the task of making informed investment decisions.
Liquidity
Equity mutual funds provide a level of liquidity. Investors can buy and sell fund units on any business day, allowing them to access their invested capital relatively quickly. This flexibility is particularly appealing to investors who might need to access their funds in case of emergencies.
Affordability
Equity mutual funds permit investors to enter the stock market with a relatively smaller amount. This democratization of stock market participation has been a pivotal factor in attracting a broader range of investors, including those who previously found such opportunities inaccessible.
Tax efficiency
Some equity mutual funds in India offer tax benefits. For instance, Equity Linked Savings Schemes (ELSS) provide investors with tax deductions under Section 80C of the Income Tax Act. This feature has made these equity mutual funds an attractive option for individuals looking to save on taxes while potentially earning returns.
Systematic investment plans (SIPs)
SIPs allow investors to contribute a fixed amount at regular intervals, such as monthly or quarterly. This strategy not only cultivates a disciplined approach to investing but also minimizes the impact of market volatility. By buying more units when prices are low and fewer units when prices are high, investors can potentially benefit from rupee-cost averaging.
Long-term wealth creation
Equity mutual funds are particularly well-suited for those with long-term investment horizons. While the stock market can experience short-term fluctuations, historical data suggests that – over extended periods – it tends to offer relatively reasonable returns compared to other asset classes . This feature of equity funds aligns well with the goals of many investors who seek to build wealth over time.
When is the right time to invest in equity mutual funds?
Mutual funds have become increasingly popular due to their flexibility, attracting investors of varying risk profiles . While investors seek the suitable mutual fund to invest in, they are also curious about the ideal timing for their investments.
There is no definitive “best” time to invest in mutual funds. The concept of timing the market to find the perfect moment to invest in equity mutual funds can be elusive. Instead of waiting for an ideal time that may never come, it is prudent to start investing today and adhere to fundamental investment principles. Moreover, it is advisable to stay invested for a longer duration to reap optimal benefits.
Why should you invest long term in Mutual funds?
Investing in mutual funds with a long-term horizon offers numerous advantages and can be highly beneficial for investors. Here are several reasons why favouring a long-term investment approach in mutual funds is advantageous:
Investing in mutual funds with a long-term horizon offers numerous advantages and can be highly beneficial for investors. Here are several reasons why favouring a long-term investment approach in mutual funds is advantageous:
- Compounding returns: Long-term investments allow the power of compounding to work. It allows your earnings to grow as your investments grow. The power of compounding works by growing your wealth exponentially over long term. It adds the profit earned back to the principal and then reinvests the entire sum to accelerate the profit earning process.
- Smoothing market volatility: Investing in mutual funds with a long-term perspective helps pacify the impact of short-term market volatility.
- Potential for higher returns: By holding equity-oriented mutual funds for the long term, investors have the potential to capture the growth of the underlying businesses and participate in the market’s upward trajectory.
- Diversification benefits: By investing in a well-diversified mutual fund portfolio, you can spread the risk and reduce the impact of any single investment’s performance.
- Aligning with financial goals: Long-term investments in mutual funds are well-suited for achieving various financial goals, such as retirement planning, funding higher education, or building wealth over an extended period.
Mistakes to avoid when investing in equity funds
Below are some mistakes to avoid while investing in an equity mutual fund.
- Ignoring your investment goals: Clearly defining your investment goals and time horizon is key before selecting equity funds. Your goals could be retirement, children’s education, down payment for a house, etc. Investing without aligning to goals leads to selecting unsuitable funds that may not meet your needs.
- Not understanding your risk tolerance: Know your appetite for risk and market volatility before investing in equity funds. Are you a conservative investor seeking reasonable returns, or do you have a high tolerance for market fluctuations? Choose mutual fund schemes that match your risk profile.
- Chasing past performance: Don’t invest in funds purely based on their past returns. Past performance does not guarantee future results. Evaluate the fund’s investment strategy and portfolio attributes before investing for potentially long-term gains.
- Neglecting to diversify: Don’t just invest in one or two funds. Diversify across fund houses, market cap categories, sectors, and investment styles to manage risks effectively. Avoid overexposure to a single fund.
- Investing based on short-term market fluctuations: Don’t time the market or make impulsive decisions based on volatility or news events. Equity investments require a long-term time frame to ride out short-term fluctuations.
- Overlooking the importance of regular investing: Invest regularly, like through SIPs, to benefit from rupee cost averaging and compounding over long periods. Sporadic lumpsum investments may often lead to poor timing and impulsive decisions.
- Failing to review and rebalance your portfolio: Review your funds periodically to check if your asset allocation matches goals. Rebalance to bring your portfolio in line with original targets.
- Making emotional investment decisions: Don’t be driven by greed or fear. Have patience and discipline when investing in equity funds. Work with a long-term perspective and ignore daily noise.
- Skipping the fine print: Make sure you understand the fund Scheme Information Document (SID) and Statement of Additional Information (SAI). Read the fund related documents like SID and SAI to evaluate investment strategy, risks, costs, etc. in detail before investing to ensure it is a suitable choice for your goals.
- Not seeking professional advice when needed: Consult an investment advisor if you lack time or expertise for research before investing in equity funds. Experts can help avoid pitfalls.
How to invest in equity funds?
Below are the key steps involved:
- Complete KYC formalities: Investors must complete Know Your Customer (KYC) registration through a SEBI-registered intermediary. This is mandatory before investing in any mutual fund scheme in India.
- Define financial goals and time horizon: Equity funds may be considered by investors potentially looking to build wealth over time. A long-term horizon may help manage market fluctuations.
- Assess risk appetite: As equity funds are high risk, investors may evaluate their ability to tolerate capital volatility.
- Choose a suitable category: Investors may review categories such as large cap fund, mid cap fund, small cap fund, multi cap fund, flexi cap fund, sectoral or thematic fund, and ELSS, based on investment objectives.
- Select mode of investment: You can invest through a lump sum amount or through a Systematic Investment Plan (SIP), contributing a fixed amount per month.
- Invest via a suitable channel: Investments can be made directly through the AMC website, through an AMFI-registered distributor empanelled with the AMC, or via registered online platforms.
- Monitor periodically: Investors may review performance relative to stated objectives and risk profile at regular intervals, without reacting impulsively to short-term market movements.
Conclusion
Equity mutual funds are market-linked investment vehicles that invest primarily in equity and equity-related instruments. They are classified as very high risk and are subject to market volatility, but they offer high potential for wealth creation over the long term when aligned with an appropriate time horizon. Different categories such as large cap fund, mid cap fund, small cap fund, multi cap fund, flexi cap fund, sectoral or thematic fund, and ELSS follow distinct investment mandates. Given their risk profile, equity mutual funds may be suitable for investors who have a long investment horizon are prepared for interim volatility.
FAQs:
Are equity oriented mutual funds taxable?
Yes, equity oriented mutual funds are taxable in most cases. Long term capital gains on equity funds held for more than one year are taxed at 10% plus applicable cess and surcharges Short-term capital gains. on equity funds held for less than one year are taxed at the individual’s applicable income tax slab rate.
What is the tax exemption on equity mutual funds?
Equity funds held for more than one year are eligible for long-term capital gains tax exemptions. Gains up to Rs.1.25 lakh are exempted from tax.
What are the advantages of building an equity portfolio with gains from liquid funds?
The main advantage is the potential for higher returns compared to keeping all your money in liquid funds. Moreover, combining liquid funds with equities can help create a balance between risk mitigation and return potential.
How to decide the proportion of liquid fund gains to allocate to equities?
This depends on your risk tolerance , investment goals, and financial needs. A balanced approach could be to start with a small investment and increase it as you become more comfortable with equity investments.
What are the typical returns I can expect from an equity portfolio built with liquid fund gains?
While past performance is not a guarantee of future returns, historically, equity portfolios have provided higher returns compared to liquid funds over the long term. Expect variability in the short term but potential for significant growth in the long run.
What is an equity investment in mutual funds, and how does it differ from other investment options?
Equity investment in mutual funds involves investing in stocks or company shares through pooled funds structure, offering the potential for higher returns compared to other investment options over long term.
Why is equity investment often recommended for young professionals?
Equity investment is often recommended for young professionals due to their longer investment horizon, higher risk tolerance, and potential for substantial long-term growth.
What is the difference between actively managed and passively managed equity mutual funds?
Actively managed equity funds are the equity funds in which the fund manager picks the stocks for the scheme. The competence and experience of the fund manager play an important role here to determine the returns from the mutual fund. On the other hand, passively managed equity funds track a market index or segment to invest. The fund manager does not play an active role here. The performance is usually dependent on the market conditions.
What is the risk associated with investing in equity mutual funds?
Investing in equity mutual funds comes with certain risks. The primary risk is market volatility, which causes fluctuations in the fund’s value. It’s essential to understand and evaluate the risks associated with equity mutual funds before investing and consider diversification and a long-term investment horizon to mitigate some of these risks.
Is flexi cap fund a type of equity fund?
Yes, a flexi cap fund is an equity fund that can invests across large, mid and small cap stocks . It has a dynamically managed portfolio, so it can freely adjust the portfolio allocation across these three market capitalisations based on market conditions. One such flexi cap fund in the market is the Bajaj Finserv Flexi Cap Fund, which follows a megatrends-based investing strategy.
Is SIP an equity fund?
A systematic investment plan (SIP) is not a fund category. It is a method of investing a fixed amount per month in a mutual fund scheme, including equity, debt, or hybrid funds.
Is 12% a good return on equity?
A 12% return in equity cannot be classified as suitable or otherwise in isolation. Different types of schemes have varying return potential and returns vary across market cycles. Investors may evaluate their fund’s performance relative to benchmarks, category peers, time horizon, risk appetite, and portfolio allocation. Past performance may or may not be sustained in future.
