Equity Mutual Funds – Types, Benefits and Who Should Invest
6 October 2022
Equity funds or equity mutual funds are mutual fund schemes that predominantly invest in company stocks and shares. As per SEBI (Securities and Exchange Board of India), equity mutual funds must allocate a minimum of 65% of their investment corpus to stocks.
Read this blog to get a complete understanding of equity funds and why you should invest in them.
What Are Equity Mutual Funds?
Equity funds primarily invest in equity shares of different companies. Fund managers of such funds attempt to generate maximum returns by diversifying the investment across various sectors and different market caps. Equity mutual funds can generate much better returns than debt funds or term deposits.
However, since these funds mainly invest in equity, their performance is impacted due to price fluctuations in the stock market. As a result, there is a considerable amount of risk associated with investments in equity funds.
Here, we have mentioned the types to help you understand equity mutual funds in a better way.
1. Large-cap Funds
They invest at least 80% of their total assets in equity shares of large-cap companies. Such companies are well-known firms with a proven track record. The returns from these funds are more stable compared to both small and mid-cap funds.
2. Small-cap Funds
Such funds invest a minimum of 65% of their total assets in equity shares of small-cap companies.
Such organisations are placed at the 251st position and below in terms of market capitalisation. These schemes are likely to offer greater returns than the mid-cap and large-cap mutual funds. At the same time, these funds carry higher financial risk.
3. Mid-cap Funds
These funds invest a minimum of 65% of their fund corpus in equity shares of mid-cap firms. Mid-cap companies refer to organizations that are ranked between 101 and 250 with respect to market cap.
These mid-cap funds tend to offer higher returns than the large-cap schemes. However, they are riskier than the latter.
4. Multi-cap Funds
Such funds invest in shares of large-cap, mid-cap, and small-cap companies and are considered by investors who like to diversify their portfolio. As per regulations of SEBI, these funds will have to invest at least 25% of the fund corpus in each of the large-cap, mid-cap, and small-cap stocks.
These funds capitalise on various opportunities across various market caps to generate optimum returns for investors.
5. Large and Midcap Funds
These funds invest a minimum of 35% in large-cap stocks and at least another 35% in mid-cap stocks. After meeting the asset allocation requirements, fund managers of such schemes decide where to invest the remaining portion of the fund corpus.
Funds that aim to generate higher returns will have more exposure to mid-cap. Moreover, they might even choose to add small-cap stocks to the portfolio. That said, fund managers might allocate funds to large-cap stocks if they wish to keep the volatility in check.
ELSS helps you save on your tax outgo. Under section 80C of Income Tax Act 1961, ELSS offers tax deductions of up to Rs. 1.5 lakh. As per the rules of SEBI, such schemes must invest at least 80% of their pooled funds in equity or equity-linked instruments. Note that in the case of ELSS schemes, there is a lock-in period of 3 years.
7. Sectoral/Thematic Funds
When equity funds invest in a specific market sector like – IT, BFSI, Pharmaceutical, etc., they are referred to as sectoral funds. Such funds bear high risk and offer less diversification as they focus on a particular theme or sector.
8. Focused Equity Funds
As per SEBI guidelines, these funds invest in a maximum of 30 stocks. They do not spread their investments over a large number of sectors. Fund managers of focused equity funds pick stocks based on the fund’s mandate to earn maximum returns for investors.
9. Contra Equity Fund
Such equity schemes follow a contrarian strategy when investing the fund corpus. Such mutual funds analyse the market to figure out low-performing stocks. After that, these equity funds purchase these stocks at lower prices under the assumption that they will perform well in the future.
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Disclaimer: Mutual fund investments are subject to market risk, read all scheme-related documents carefully.
How Do Equity Mutual Funds Work?
Equity mutual fund schemes primarily invest in equity shares of companies in various proportions. The asset allocation depends on the type of equity fund – large cap, small cap or mid cap.
Note that a major portion of the corpus goes to equity shares, not all. The remaining amount gets invested in the money market and debt instruments. Since debt instruments like government bonds and securities carry lower risks compared to equity, this helps bring down the element of risk.
You can invest in equity mutual funds via SIP (Systematic Investment Plan) or in lump sum.
Benefits of Investing in Equity Mutual Funds
Here are some benefits of investing in equity mutual funds:
An equity fund offers a perfect mix of diversification as you can invest your money in stocks of companies across varied market capitalisations.
It reduces the inherent risk associated with investment in mutual funds. A fall in price of one stock can be compensated with corresponding increase in price of other stocks, thereby providing stability to the portfolio.
Investments made in ELSS funds of up to Rs 1.5 lakh are eligible for tax deductions u/s 80C of the IT Act; this helps in reducing your gross tax liability.
Moreover, LTCG returns of up to Rs. 1 lakh upon redemption of fund units after a holding period of 1 year or more is tax-exempt.
Equity mutual funds have a higher growth potential than debt-oriented mutual funds. The fund managers strategically invest in stocks of companies that can provide high returns annually; this is especially true for stocks of small-cap companies that are still in their growth phase.
Starts from low investment
Another benefit of investing in equity-oriented funds is minimal initial investment. You need not worry if you do not have a big investment corpus; you can start investing in these funds via a Systematic Investment Plan.
The minimum investment amount can be as low as Rs. 500.
Mitigation of risk
Diversification and mitigation of risk are interrelated. As these mutual funds invest across diverse equity instruments, it somewhat reduces the risk associated with the volatility of stock markets.
The risk cannot be eliminated completely; however, meaningful allocation across a spectrum of equity opportunities helps to mitigate risk.
Who Should Invest in Equity Mutual Funds?
If you can take high risks and are looking to earn higher returns than debt funds or bank fixed deposits, equity mutual funds can be a suitable option for you. That said, since they carry high financial risk owing to stock market volatility, you must assess your risk profile before investing.
Equity funds are further segregated into various types based on factors, such as market cap and investment strategy. Make sure to invest in a fund that’s in line with your financial goals.
Taxation of Equity Mutual Funds
In the case of equity mutual funds, any returns earned against the sale of units within 12 months will be considered as short-term capital gains (STCG). Such gains are taxed at a flat rate of 15%.
On the other hand, the returns earned after selling a mutual fund after 12 months are known as long-term capital gains (LTCG). Returns exceeding Rs. 1 lakh will get taxed at a rate of 10%. Note that no indexation benefit is available in this case.
For saving taxes against your mutual fund returns, you may consider investing in equity-linked insurance schemes or ELSS.
It is the best tax saving option as per section 80C of the Income Tax Act 1961. In the case of equity-linked schemes, you will get tax deductions of up to Rs. 1.5 lakh as per section 80C of the Income Tax Act, 1961.
Also, note that in the case of long-term capital gains, no tax will be levied on returns of up to Rs. 1 lakh.
Things to Consider When Investing in Mutual Funds
You must make sure to consider the following aspects before investing in equity mutual funds:
First, decide on your investment goal before choosing to invest in mutual funds. Your investment goal can be financing your child’s higher education, building a retirement fund, etc.
Performance of the Fund
It is necessary to consider the performance of a mutual fund before parting with your savings. This gives you an idea regarding the consistency of the fund and whether it is being able to fulfil the goal that it was set up to fulfil.
It is a fee charged by fund houses every year for managing a mutual fund scheme. Before allocating your money to any scheme, check the expense ratio and compare it with the category average.
Fund Manager’s track record
You must check the credentials of a fund manager before investing in a mutual fund. After all, whether or not a fund can achieve its objective depends on the fund managers’ skillset and experience.
Equity mutual funds have the potential to provide higher returns. However, there’s a certain degree of risk associated as a major share of the corpus is invested in equity shares of companies.
However, you can still mitigate the risk by opting for a mutual fund scheme based on its market cap – large cap carries less risk than small cap. To sum it up, invest based on your investment goals and risk appetite. Keep your portfolio diversified to mitigate risk.
Frequently Asked Questions
Q1. What is a lock-in period in mutual funds?
Ans: The Lock-in period of mutual funds refers to the time duration for which you are not allowed to redeem the fund units either wholly or partially.
Q2. What is SIP in mutual funds?
Ans: SIP stands for a systematic investment plan. It is a way of investing in mutual funds and is quite useful as mutual funds are an unpredictable game. Through SIP, you can invest a fixed sum of money regularly in a mutual fund. A SIP ensures that you are invested at the high as well as low points.
Q3. Is FD better than equity funds?
Ans: FDs offer you fixed returns with minimal risk. In comparison, mutual funds offer higher returns, but the associated risk level is higher as well. Make sure to consider aspects, such as investment objectives, risk appetite, etc., before deciding whether to opt for a bank FD or a mutual fund scheme.
Q4. Do equity funds come with a lock-in period?
Ans: ELSS funds are the only sub-category of equity funds that come with a lock-in period of 3 years. No other has a lock-in period; you can redeem your units after placing a redemption request.
Q5. Should I invest in a large-cap or multi-cap fund?
Ans: Whether you should opt for a large-cap fund or a multi-cap fund depends on factors, such as your risk appetite, financial goals, etc. Make sure to consider these aspects before making a decision.
Before you go…
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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