What are Equity Mutual Funds?

By investing in equity mutual funds, you open the doors to high returns from your investments. They spread your funds across companies of various sizes, which can enhance your chances of earning more. However, it is essential to remember that mutual funds are high-risk investments. This means that while there is the potential for significant gains, there is also the possibility of losses. Therefore, it is crucial to assess your risk tolerance and investment horizon before diving into equity mutual funds. Learning about equity mutual funds and staying informed with their pros and cons can help mitigate risks and maximize your investment potential.

What is an Equity Mutual Fund?

Equity mutual funds are essentially high-risk investments that use your money to purchase a diversified portfolio of stocks. Unlike investing in individual stocks, where you're responsible for selecting and managing your own investments, equity mutual funds are professionally managed. There is a fund manager, often a team of experts, who oversees the fund's investments, making decisions about which companies to buy or sell based on different factors.

Types of Equity Mutual Funds

According to the Securities and Exchange Board of India (SEBI) mandate, for a fund to qualify as an equity mutual fund, at least 65% of its assets must be invested in equity and equity-related instruments. They have also categorized equity funds based on market capitalization, ensures clarity for investors regarding the types of companies these funds invest in.

Investment Strategy-Based Categories

Thematic or Sectoral Funds: If you're excited about a specific investment area like tech or healthcare, this might be for you. These funds focus on a particular industry or theme, but remember, this comes with higher risk since you're not spreading your investment across different sectors.

Focused Equity Fund: Here, the fund invests in a small group of about 30 companies. The idea is that by focusing on fewer stocks, the fund can concentrate on finding the best opportunities.

Contra Equity Fund: Think of this as a "rebel" fund. It goes against the grain, investing in companies that are currently underperforming, with the belief that they will bounce back in the long run.

Dividend Yield Equity Fund: This equity fund invests primarily in stocks of companies known for consistently paying high dividends. And provides a steady stream of income through dividend payouts.

Market Capitalization-Based Categories

This is all about the size of the companies the fund invests in.

Large-Cap Funds: These funds invest in the top 100 biggest companies. Since these are well-established businesses, it's a safer bet for those looking for steady, long-term growth.

Mid-Cap Funds: Here, the focus is on medium-sized companies ranked 101-250. These funds come with a bit more risk than large-cap funds but also offer the potential for higher returns.

Small-Cap Funds: If you’re feeling adventurous, small-cap funds invest in smaller companies ranked 251-500. These are riskier but can deliver significant gains if the companies grow.

Multi-Cap Funds: A good mix of large, mid, and small-cap companies. These funds give you the best of all worlds by diversifying across company sizes, balancing risk and reward.

Large and Mid-Cap Funds: A blend of large and mid-sized companies, giving you a mix of stability and growth potential.

Tax Treatment-Based Categories

Equity Linked Savings Scheme (ELSS): This is a tax-saving option where you can invest in equity funds and save on taxes. It has a lock-in period of three years and is great if you’re looking for both tax benefits and long-term growth.

Investment Style-Based Categories

Active Funds: In these funds, a fund manager actively picks and chooses stocks to buy, aiming to outperform the market.

Passive Funds: These funds just track a particular market index, like the Nifty 50. The fund manager's job here is to replicate the picked stocks actively.

How Does an Equity Mutual Fund Work?

Let's break down the working of this popular mutual fund type:

Pooling of Funds: Investors contribute money to the fund.

Investment Selection: The fund manager selects stocks based on the fund's investment objective.

Portfolio Management: The manager monitors the performance of the investments and makes adjustments as needed.

Distribution of Returns: The fund distributes profits to investors in the form of dividends (based on the scheme) or capital gains.

Advantages and Disadvantages of Equity Mutual Funds

To provide a clearer perspective, we have listed the advantages and disadvantages below.

Advantages:

Potential for High Returns: Equity mutual funds have the potential to generate substantial returns over the long term because they invest primarily in stocks. This happens because of the growth of companies and the overall economy, which can lead to an increase in stock prices.

Professional Management: When you invest in equity mutual funds, you benefit from the expertise of professional fund managers. These managers are skilled professionals who analyze market trends, evaluate companies, and make informed investment decisions on behalf of the fund's investors. They have access to research, tools, and resources that individual investors may not have. 

Liquidity: Equity mutual funds offer a high liquidity; meaning that you can easily buy or sell your units whenever you need to access your money. Unlike certain investments, such as real estate or fixed deposits, which may take time to liquidate, mutual funds allow you to redeem your units on any business day at the current Net Asset Value (NAV). 

Disadvantages:

Market Risk: Equity mutual funds are subject to market risk, so the value of the fund can fluctuate based on the performance of the underlying stocks. When the stock market experiences volatility, equity mutual funds can see significant swings in their NAVs. This volatility is particularly impactful in the short term, as the market can react quickly to news and events. So be prepared for the possibility of losses, especially if you need to redeem the units during a market downturn.

Management Fees: Investing in equity mutual funds comes with certain fees to cover the expenses associated with running the fund, administrative expenses, etc. The expense ratio is typically expressed as a percentage of the fund's assets and is deducted from the fund's returns before they are distributed to you. While the fees may seem small, they can have a significant impact on long-term returns, especially in low-return environments.

Short-Term Volatility: Equity mutual funds can experience significant price swings in the short term because of the volatility of the stock market. This volatility can be unsettling, especially if you are new to the market or have a low tolerance for risk.  

Who Should Invest in Equity Mutual Funds?

Equity mutual funds are suitable for investors who:

• Have a long-term investment horizon.
• Are comfortable with market risk.
• Seek potential for high returns.
• Want to benefit from professional management.

Key Things to Keep in Mind While Investing in Equity Mutual Funds

Risk Tolerance: Assess your ability to withstand market fluctuations.

Fund Selection: Choose a fund that aligns with your investment goals and risk profile.

Investment Horizon: Consider your long-term financial objectives.

Monitoring and Rebalancing: Regularly review your investments and make adjustments as needed.

Tax Obligations on Equity Mutual Funds

Investing in equity mutual funds can yield significant returns, but it's important to understand the tax implications associated with these investments. The taxation on equity mutual funds in India primarily revolves around capital gains (both short-term and long-term) and dividends. Here's how taxes apply:

1. Short-Term Capital Gains (STCG):

If you sell your equity mutual fund units within one year of purchase, the profit you earn is classified as a short-term capital gain.

Short-term capital gains on equity mutual funds are taxed at a flat rate of 20%.

If you purchased equity mutual fund units worth ₹1,00,000 and sold them within a year for ₹1,20,000, the gain of ₹20,000 would be taxed at 20%. Thus, you would need to pay ₹4,000 as tax on your short-term capital gains.

2. Long-Term Capital Gains (LTCG):

If you hold your equity mutual fund units for more than one year before selling them, the profit earned is classified as a long-term capital gain.

Long-term capital gains exceeding ₹1.25 Lakhs are taxed at 12.5%. Gains up to ₹1.25 Lakhs are exempt from tax.

Suppose you bought equity mutual fund units worth ₹1,00,000 and sold them after two years for ₹1,50,000. The total gain is ₹25,000. Since the first ₹1.25 Lakhs of long-term gains are exempt, and your gain is only ₹25,000, your tax liability would be ₹3,125.

3. Dividends:

Dividends are periodic payments made by mutual funds to their investors, usually out of the profits earned from the fund’s investments.

Dividends received from equity mutual funds are added to your total income and taxed as per your applicable income tax slab rate.

How to Invest in Equity Funds?

You can use INDmoney to invest in the best equity mutual funds easily by following these steps:

• Open the INDmoney app and log in with your credentials.
• Navigate to the "Mutual Funds" section within the app.
• Use the filter to select "Equity Funds" to view the available options.
• Choose between a lump sum investment or a Systematic Investment Plan (SIP) for regular investments.
• Enter the amount you wish to invest and confirm the transaction.