Why equity mutual funds are suitable investment options for potential wealth creation

Equity funds predominantly invest in company stocks. In a growing economy, such investments have significant potential to build wealth over time.

However, equity investments tend to be volatile and are heavily influenced by market trends and investor sentiment. It is thus important to maintain checks and balances while investing.

This is where mutual funds come in. Mutual fund portfolios are professionally managed. Fund managers carefully select assets based on the scheme category and investment objective. They build a diversified portfolio that seeks to mitigate risk and optimise return potential.

This article explores the reasons why equity mutual funds can be a powerful tool for wealth creation in India.

• Table of contents

1. Benefits of equity mutual funds for wealth creation
2. Factors to consider when investing in Equity Mutual Funds
3. FAQs

Benefits of equity mutual funds for wealth creation

Portfolio diversification: Equity mutual funds hold a basket of multiple stocks. They can also diversify across various sectors and market capitalizations. This mitigates risk, as a decline in one asset’s performance can potentially be offset by gains in others. Equity mutual funds may also invest a small portion in fixed-income assets, which can bring relative stability to a portfolio.

Professionally managed: Unlike direct stock investments, equity mutual funds benefit from the expertise of experienced fund managers. They analyze the market, study company performance and make informed investment decisions. This expertise can help investors navigate the complexities of the stock market and potentially optimise returns.

Low capital requirement: Mutual funds pool investor money and invest it in a diversified basked of equity, debt or other instruments (based on the scheme category). The pooling of money allows individual investors to access a diversified portfolio even with small investment amounts.

Capital growth: Equity funds have the potential to build wealth over the long term with the power of compounding. This happens when the potential returns on your assets are reinvested into the market to earn further potential returns.

Leveraging volatility:Equity markets are volatile. Systematic Investment Plans (SIPs) can potentially use that volatility to an investor’s advantage. SIP require you to invest a fixed amount regularly, regardless of market conditions. As a result, you buy more units when the markets are down and fewer when the markets are up without needing to independently time the market. Over time, this typically tends to reduce the per-unit cost of your investment – a phenomenon known as rupee-cost averaging. This can potentially optimise returns when the market bounces back.  

Liquidity: Most equity mutual funds offer high liquidity, allowing you to redeem your investments at the prevailing Net Asset Value (NAV) on business days. This flexibility is valuable, especially in unforeseen circumstances.

Tax benefits: Investing in Equity Linked Savings Schemes (ELSS) provides tax-saving benefits under Section 80C of the Income Tax Act, 1961. Additionally, capital gains tax on equity funds is relatively favourable, especially for long-term investments.

Factors to consider when investing in Equity Mutual Funds

Before investing in equity mutual funds, it's essential to consider several factors:

• Investment horizon: Equity markets are volatile, and short-term fluctuations are common. Equity mutual funds are suited for investors with a long-term investment horizon (five-to-seven years or more). This allows investors to potentially ride out market slumps. A longer horizon can also optimise the potential compounding effect on investments.
• Risk tolerance: Equity funds carry several risks due to market fluctuations. Such investments may not suit very conservative investors. However, diversification can help mitigate some of these risks. Moreover, some equity funds may be less vulnerable to volatility than others. Large cap funds, for example, which invest in stocks of established companies, can be relatively stable compared to mid or small cap funds.
• Investment objective: Clearly define your financial goals (retirement, child's education, etc.) and the time frame to achieve them. This will guide your selection of the appropriate fund category and investment strategy.
• Expense ratio: The expense ratio is the annual fee charged by the fund house to manage the fund. Lower expense ratios translate to potentially higher growth for investors.

Conclusion

Equity mutual funds can be a suitable option for investors seeking potential capital appreciation over the long term. The diversification and professional management of mutual fund portfolios can help mitigate some of the risks associated with equity investing and make the financial market accessible to novice investors. By carefully considering your investment horizon, risk tolerance, and financial goals, you can select an equity mutual fund that aligns with your needs.

FAQs

What is the minimum investment required for equity mutual funds?
The minimum investment requirement can vary from one fund house and scheme category to another. However, several schemes offer investments starting from as low as Rs. 500 through SIPs.

How are equity mutual funds different from other types of mutual funds?
There are several mutual fund categories in India. Equity mutual funds primarily invest in stocks. Debt mutual funds invest in debt securities. Hybrid mutual funds invest in both equity and debt securities.

Are equity mutual funds suitable for short-term investment goals?
Equity mutual funds are generally more suitable for long investment horizons because markets can be volatile in the short term.

How can I monitor the performance of my equity mutual fund investments?
Tracking your scheme’s NAV and comparing returns to that of its benchmark and category peers can give you an idea of how your investment is performing. Read the mutual fund factsheet and other portfolio disclosures that are routinely sent to investors to keep track of your investments.

What are the tax implications of investing in equity mutual funds?
Equity funds held for over the year are subject to a long-term capital gains tax of 10%. The short-term capital gains tax (for investments held under a year) is 15%. Additionally, Equity-Linked Savings Scheme or ELSS mutual funds are eligible for tax deduction benefits under Section 80C of the Income Tax Act, 1961.

Can I switch between different equity mutual funds?
Yes, investors can switch between different equity mutual funds based on their investment objectives, risk tolerance, and market conditions. However, it's essential to consider any exit loads and tax implications before making switches.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.