What are Growth Funds – Benefits, Types, Risks & Who Should Invest
Growth funds are mutual fund schemes that primarily invest in the shares of promising companies that are growing at a rate faster than the overall stock market. Stocks of these rapidly-growing companies carry high risk, but they also offer significantly higher returns during favourable market conditions.
This post discusses what growth funds are, their types, benefits, risks and taxation. Read before you invest!
What are Growth Funds?
Growth funds are high-risk, high-return mutual fund investments. These invest in shares of budding companies showing immense potential and growth. If you have a high-risk appetite, growth funds are perfect for you to invest in. Growth funds are best for long-term investment. However, if you want to exit the fund early, an exit load shall be charged.
How Do Growth Funds Work?
Growth funds offer their investors a diversified portfolio of high-growth stocks. These mutual fund schemes invest in companies that are known for their potential to attain exceptionally high revenue and profits. Thus, you can obtain maximum capital appreciation by investing in growth funds.
Indeed, these schemes are one of the riskiest mutual fund options in the market. That said, investors with a medium-to-long-term investment horizon counter any short-term market volatility.
These funds steer clear of companies that have a high dividend yield. This helps the fund to focus only on capital gains and on delivering high returns. The gains that the fund house makes through this scheme are reinvested in the portfolio itself. This compounding feature makes growth funds unique and famous among investors.
Types of Growth Funds
Based on the market capitalisation of the companies that the scheme invests in, growth funds can be of various types:
1. Large Cap Funds
Under this scheme, the fund manager invests about 80% of the total corpus in large-cap companies. These companies are well-established and are ranked between 1 and 100 in terms of market capitalisation.
2. Mid Cap Funds
The fund manager of this scheme invests at least 65% of the total assets in mid cap companies. As these companies are still establishing themselves, investing in them can be riskier than large cap companies. However, mid cap companies have a better potential to grow at a faster rate.
3. Small Cap Funds
Small cap funds invest 65% of the fund corpus in equity shares of small cap companies. These funds have the potential to generate higher returns than mid cap funds and large cap funds. That said, the associated risk is higher as well.
Benefits of Investing in Growth Funds
Investors can enjoy a wide range of benefits by investing in growth funds. Some of these advantages are as follows:
- Massive growth potential and returns: There is no guarantee that the large cap funds can generate market-beating returns. But if the market conditions remain favourable, you can receive significant returns.
- Expert management: An experienced fund manager handpicks the stocks of companies displaying an impressive growth trajectory. These professionals put in a lot of effort in identifying the best stocks in the stock market. Thus, despite the risk, the expert buying and selling decisions of a fund manager can generate significant returns.
- Portfolio diversification: In the portfolio of a growth fund, you will find a prudent mix of high-growth stocks. Due to this diversification, not only do you get to enjoy the growing returns of multiple stocks, but it also reduces the impact of market fluctuations.
- Reinvestment: A primary and unique benefit of a growth fund comes from its reinvestment feature. The fund house reinvests the gains or earnings of this scheme into its further expansion. These gains can also be allocated towards research and development to make the scheme stronger.
Risks Involved with Growth Funds
So far, it must be clear that growth funds do not come without their own cons. Before investing in them, make sure to go through some of these major risks involved:
- Market volatility: The most obvious disadvantage of these schemes is their dependency on the stock market. Investing most of their total assets in shares of various companies means that during market downturns, your returns can suffer massive blows.
Due to being highly sensitive to market fluctuations, the Net Asset Value of the fund tends to rise and fall frequently. - No dividend payout: Growth funds tend to not include the stocks of companies that pay monthly, quarterly or annual dividends. Thus, unlike dividend funds, you are not assured of a stable passive income, and you enjoy no protection against inflation.
- Additional costs: To manage and maintain a fund, Asset Management Companies charge various fees that can adversely affect your overall returns. Expense ratio has an impact on the returns you earn from a mutual fund scheme. Thus, while making an investment decision, it is vital to take a look at a scheme’s expense ratio.
Growth Fund Taxation
Taxation is applicable to the capital gains of these schemes. As these are a type of equity fund, your returns fall under the short term capital gains category if you exit the fund before 12 months. A tax rate of 15% applies to your short term capital gains.
If you sell your units in a mutual fund scheme after a period of 12 months, long term capital gains tax of 10% is levied on your realised returns. Note that tax is not applicable if your long term capital gains are less than Rs. 1 lakh.
Who Should Invest in Growth Funds?
The following can choose to invest in growth funds:
- Investors who are seeking significant capital appreciation
- Individuals who are looking to maximise their portfolio returns by investing in equity
- Investors who do not have time to track the market constantly
- Investors who are seeking professional expertise
- Individuals who are seeking diversified equity exposure
In the digital world, investing in mutual funds is extremely convenient and hassle-free. You can either invest directly with a fund house or take the help of an intermediary. The former means that you will invest via a direct plan, and through the latter, you will invest via a regular plan. Both these plans bring along their own sets of pros and cons.
A direct plan of a mutual fund scheme comes with a lower expense ratio than a regular plan as it does not involve any third-party agent (distributor/broker). Visit Navi Mutual Fund and start investing in any of the equity-oriented mutual fund schemes today.
Final Word
Individuals can earn substantial returns by investing in rapidly-growing companies. A team of qualified professionals manage and handpick the best stocks for maximum capital appreciation. However, before you invest in growth funds, consider various aspects, such as experience of the fund manager, past returns of the scheme, investment objective and risk appetite.
FAQs
Investors across the globe have different financial goals and investment portfolios. What they are looking for in a growth fund can vary from other investors. However, by using a mutual fund comparison tool, you can analyse which growth fund is the best fit for your portfolio.
Capital appreciation refers to an increase in an investment’s market price. In simpler terms, it is the amount your mutual fund gains since you first invested in it. So, if you made an investment of Rs. 5,000, and the value rises to Rs. 6,500, then there is a capital appreciation of Rs. 1,500.
No, growth funds, except ELSS funds do not have a lock-in period as they are open-end mutual fund schemes. Individuals can redeem their units in a growth fund at their convenience. Once an individual decides to opt out of a scheme, he/she can place a request with the asset management company for the same.
A fund house charges expense ratio to cover the cost of managing a mutual fund scheme. However, it does not include charges related to purchasing or redeeming the units of a fund. Thus, you will have to pay certain charges like exit load and STT separately.
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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.
