Investing in the stock market can be a productive way to grow wealth and achieve financial goals. However, for many individuals, the complexities of stock picking and the risks associated with individual company stocks can be intimidating. equity funds, a popular investment vehicle that offers a simple and diversified approach to tapping into the potential of the stock market.
In this article, we will explore what equity funds are, their types, and why you should invest in them.
What are equity funds?
A mutual fund scheme that primarily invests in equity stocks is known as an equity fund. According to the current SEBI Mutual Fund Regulations in India, an equity mutual fund scheme must invest at least 65% of its assets in stocks and securities that are related to securities markets. An equity fund may be managed actively or passively. Passive management is used in index funds and ETFs.
Equity mutual funds are primarily categorised based on categorisation and investment style of the portfolio's holdings. Market capitalisation establishes an equity fund's size, and the stock holdings of the fund serve to classify equity mutual funds according to their investment approach.
Types of equity funds
There are several types of equity funds that investors can choose from, depending on their investment objectives:
- Large-Cap equity funds
Large-cap equity funds invest in stocks of large-cap companies, which are top 100 stocks on the basis of market capitalisation listed on the stock exchange. These companies are comparatively stable and tend to provide resilience to market volatility. Discover more about large cap mutual funds on ‘What are Large Cap Mutual Funds?’ - Mid-Cap equity funds
Mid-cap equity funds invest in stock of mid-cap companies, which are listed on the exchange from 101 to 250 position on the basis of market capitalisation and have the potential to grow at a moderate pace and provide high returns. However, these funds come with relatively high risks. Discover more about mid-cap mutual funds on ‘What are Mid Cap Mutual Funds?’ - Small-cap equity funds
Small-cap equity funds invest in stock of small-cap companies, which are listed on the exchange from 251 to 500 position and have the potential to generate high returns. These companies are highly risky and have the potential to witness significant growth in the long run. Discover more about small-cap mutual funds on ‘What are Small Cap Mutual Funds?’ - Multi-cap equity funds
Multi-cap equity funds are diversified funds that invest in stocks of companies across all market capitalisations. They tend to balance the risk-return ratio due to diversified market-cap exposure. Discover more about multi-cap mutual funds on ‘What are Multi Cap Mutual Funds?’ - Sectoral equity funds
Sectoral equity funds invest in stocks of companies from a specific sector, such as banking, IT, pharmaceuticals, etc. The returns of these funds are closely linked with the performance of the sector. Discover more about sectoral equity funds on ‘What are Sectoral Mutual Funds?’ - Thematic equity funds
Thematic equity funds invest in stocks of companies from a particular theme, such as digital technology, clean energy, etc. These funds tend to carry a higher risk as they focus on a specific theme that may witness significant ups and downs. Discover more about thematic equity funds on ‘What are Thematic Mutual Funds?’ - International or global equity funds
These funds invest in stocks of companies based outside the investor's home country, providing exposure to international markets and potentially diversifying investments across geographies. Discover more about International or global equity funds on ‘What are International Mutual Funds?’ - Index equity funds (passive funds)
Index funds aim to replicate the performance of a specific stock market index, such as the Nifty 50 or S&P BSE Sensex. They don't rely on active management and tend to have lower expense ratios than actively managed funds.
Why invest in equity funds?
- Higher returns
Investing in equity funds comes with the potential for high returns. Over the long run, equity funds have generated significantly higher returns than traditional investment options such as fixed deposits, savings accounts, and bonds. By investing in equity funds, investors can aim to earn long-term returns while beating inflation. - Diversification
Equity funds offer investors diversification across different sectors, companies, market capitalizations, and themes. By spreading their investments across different stocks, investors can manage the risk and achieve better investment returns. - Liquidity
Equity funds are highly liquid, meaning investors can easily buy and sell their funds on the stock market. This allows investors to take advantage of market trends and make investment decisions that align with their financial goals. - Accessibility
Equity funds provide an accessible entry point for investors who might not have the time, expertise, or capital to construct a well-diversified stock portfolio on their own. With a relatively low initial investment, individuals can gain exposure to a diversified basket of stocks through the fund.
How to invest in an equity mutual fund?
Before taking the plunge into the world of equity mutual funds, it's crucial to conduct a comprehensive evaluation of your financial objectives, risk tolerance, and investment timeline. To facilitate this process, we can categorise investors into two broad groups: newcomers and experienced investors.
- For First-time equity fund investors
Many individuals new to the investment scene often approach equity mutual funds as a practical choice. This is often due to limited initial capital (common among younger investors), a lack of time for constant investment monitoring (a necessity for direct stock investments), or a shortage of expertise in stock selection. In such cases, equity mutual funds emerge as an attractive option. Nevertheless, it's worth noting that there exists a variety of equity funds, making the selection process somewhat challenging. New investors can consider Large-Cap Equity Funds. These schemes primarily channel investments into top-notch market companies with a track record of delivering consistent returns. - For the experienced investors
For experienced investors it is encouraged to explore diversified equity funds and take calculated risks. The understanding of the market is significantly important in selecting the most suitable scheme and achieving superior returns compared to other equity fund options.
Who should invest in equity mutual funds?
Equity-oriented funds are the funds with at least 65% equity holdings, considered for tax computation. Here are the types of investors who should invest in equity mutual funds:
- Busy investors: Provides stock market exposure without needing time for research or market tracking; managed by professionals.
- Small investors: Allows starting with amounts as low as Rs. 100.
- Long-term goals: Suitable for investors with goals over 5 years, like retirement or children's education.
- Tax-saving and wealth growth: ELSS, a type of equity fund, offers tax benefits under Section 80C while providing good returns.
Tax on equity mutual funds
Understanding the taxation of dividends and capital gains in equity funds is essential for investors. Here is a concise overview:
- Dividends and capital gains from equity funds are subject to taxation. Capital gains represent the difference in purchase and redemption prices of mutual fund units.
- Opting for the dividend plan of the equity fund allows investors to receive dividends when surplus corpus is available.
- Dividend earnings are added to the investor's income and taxed based on their income tax slab, ranging from 20% to 30%.
- Capital gains taxation depends on the holding period. Short-Term Capital Gains (STCG) tax at 15% applies if held for less than 12 months.
- Long-Term Capital Gains (LTCG) tax at 10% applies if held for more than 12 months, exceeding Rs. 1 lakh.
