What are equity mutual funds?
Equity mutual funds are investment vehicles that primarily allocate capital to stocks or equities. These funds offer investors the potential for substantial capital appreciation over the long term by investing in shares of publicly traded companies. Equity mutual funds come in various forms, including actively managed funds, sector-specific funds, and more. They cater to investors seeking growth opportunities who are willing to accept higher volatility in exchange for potentially higher returns.
How do equity funds work?
Equity funds pool money from multiple investors and invest in a diversified portfolio of stocks. There are various types of equity funds such as mid cap fund, large cap fund, flexi cap fund, etc. The fund manager selects stocks based on various factors such as company fundamentals, industry outlook, and market trends. The goal is to achieve capital growth by investing in companies with strong growth potential or undervalued stocks that have the potential to appreciate over time.
Unlike debt funds, where returns are primarily generated through interest income, equity funds derive their returns from capital gains – the difference between the purchase price and the selling price of the stocks held in the portfolio. These funds may also distribute Income Distribution cum Capital Withdrawal (IDCW) to investors, which could be a portion of the profits earned by the underlying companies.
Who should invest in equity mutual funds?
Equity funds are suitable for investors with a longer investment horizon and a higher risk tolerance. They can be suitable for individuals seeking to build wealth over time, such as young professionals, retirement savers, and those with long-term financial goals. While equity mutual funds offer the potential for higher returns compared to debt funds, they also come with higher volatility and a higher risk of capital loss.
Investors looking to diversify their investment portfolio and make use of the growth potential of the stock market may consider allocating a portion of their assets to equity funds. However, it's essential to align investment decisions with personal financial goals, risk tolerance, and time horizon. This is because different equity funds may have different investment objectives. For instance, large-cap funds are well-suited for conservative investors seeking stable long-term returns, whereas mid-cap funds are more appropriate for moderately risk-tolerant investors pursuing long-term growth, albeit with slightly higher risk.
What are the types of equity mutual funds?
SEBI categorizes equity mutual funds In India into several segments:
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Large cap funds: Invests in the top 100 companies by market capitalisation, known for their stability and lower risk. These funds allocate at least 80% of assets to large cap companies.
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Mid cap funds: Focuses on companies ranked from 101st to 250th by market capitalisation. They target younger companies with higher growth potential, allocating at least 65% of assets to mid-cap stocks.
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Small cap funds: Invests in companies ranked beyond the top 250 by market capitalisation, known for their higher risk and potential for substantial growth. These funds allocate a minimum of 65% of assets to small cap companies.
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Large and mid cap funds: These funds invest in both large and mid-sized companies, balancing stability with growth potential. They allocate at least 35% of assets to both large and mid-cap stocks.
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Flexi cap funds: Offers flexibility by investing across companies of all sizes based on market conditions. They invest a minimum of 65% in equity and equity-related instruments.
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Multi cap funds: Invests across large-cap, mid-cap, and small-cap stocks, providing a blend of stability, growth potential, and flexibility. These funds must invest at least 75% of assets in equity and equity-related instruments. Also, a minimum of 25% should be invested in equity instruments of large-cap, mid-cap and small-cap each.
Features and benefits of equity mutual funds
Equity funds offer a range of benefits that make them a suitable option for investors seeking growth opportunities while managing risk. Here are some key advantages:
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Professional management: Managed by skilled fund managers who make investment decisions.
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Diversification: Spreads investments across multiple stocks to reduce risk.
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Liquidity: Units can be sold daily at the current NAV, ensuring easy access to funds.
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Growth potential: Aims for long-term capital appreciation through equity investments.
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Expertise access: With equity funds, you can benefit from fund managers' stock analysis and informed decisions.
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Affordability: Access diversified portfolios with a modest initial investment.
Taxation rules of equity mutual funds
Understanding the tax implications of equity funds can help you plan and optimize your investments effectively. Here are the taxation details for different types of equity mutual funds:
Income Distribution cum Capital Withdrawal (IDCW): IDCW includes dividends and capital gains distributed by mutual fund schemes. Dividends are added to the investor’s taxable income and taxed as per their income tax slab rate. Dividends exceeding Rs. 5,000 are subject to a standard TDS rate of 10%.
Capital Gains Tax: When selling mutual fund units at a profit:
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As per the 2024 Union Budget, short-term capital gains (held for less than 12 months) from equity funds are taxed at 20%, plus surcharge and cess.
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As of the 2024 Budget, long-term capital gains (held for 12 months or more) up to Rs. 1.25 lakh per year are tax-free. Gains exceeding this limit are taxed at 12.5%, plus surcharge and cess.
Things to consider while investing in equity mutual funds
Before investing in an equity fund, investors should conduct thorough research and consider the following factors:
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Investment objective: Determine whether the fund's investment objective aligns with your financial goals, whether it's capital appreciation, IDCW income, or a combination of both.
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Risk profile: Assess your risk tolerance and investment horizon to choose an equity fund that matches your risk-return preferences.
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Fund performance: Evaluate the historical performance of the fund, considering both short-term and long-term returns relative to its benchmark and peer group.
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Fund manager expertise: Research the track record and experience of the fund manager in managing equity portfolios and their investment strategy.
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Diversification: Consider the diversification benefits offered by the fund's portfolio across different sectors, industries, and market capitalizations.