Equity Mutual Funds

Equity mutual funds are a type of mutual fund that invests a major portion of its funds in stocks. They are often said to be a good investment option for the long term. In this article, we will take a detailed look at what equity mutual funds are, how they work, what should you consider before investing in them, the benefits of equity mutual funds, and more.

If you are wondering what mutual funds are and how they work, please read our detailed article about mutual funds and how you can choose the right one for you and your goals. Equity mutual funds invest a major portion of your money in equities and stocks of different companies. They are also known as Growth Funds. These funds generate higher returns than fixed deposits or debt mutual funds. However, these funds come with a certain amount of risk since their performance and return is dependent on the equity market situation.

Equity mutual funds invest 60% of their assets in a variety of companies in suitable proportions. The asset allocation will be in line with the investment objective. The assets will be allocated purely in stocks of large-cap, mid-cap, or small-cap companies, depending on the market conditions.

A major portion goes towards the equity segment while the rest of the amount may go into debt and money market instruments. This move is done to handle sudden redemption requests and lower the risk level to some extent. The fund manager makes buying or selling decisions to take advantage of the changing market movements and reap maximum returns.

The main goal of equity mutual funds is capital appreciation, but it also depends on the types of stocks that the fund invests in. Below are the types of equity mutual funds.

Large-Cap Equity Funds - This equity mutual fund invests a minimum of 80% of its assets in companies that rank between 1 and 100 in terms of full market capitalization. These funds are relatively less risky compared to mid-cap and small-cap funds.

Mid-Cap Equity Funds - These equity funds invest a minimum of 65% of their assets in equity shares of companies that rank between 101-250 in terms of market capitalization. They are relatively riskier than large-cap funds. However, they have the potential to generate better returns than large-cap funds.

Large & Mid-Cap Funds - These equity funds invest a minimum of 35% of their assets in both large-cap and mid-cap companies. The remaining 30% of the assets can be invested in equities other than large and mid-cap and/or debt and money market instruments and such other securities as may be permitted by SEBI.

Small-Cap Funds - This equity mutual fund invests a minimum of 65% of its assets in equity shares of companies that rank 251 and above in terms of market capitalization. These funds are riskier than large and mid-cap funds but have the potential to provide reasonable returns.

Multi-Cap Funds - These equity funds invest in large-cap, mid-cap, and small-cap companies according to the relevant market conditions. This fund gives the investors an opportunity to invest in a diversified portfolio across market capitalization.

These are the major investment strategies followed by the fund house.

There are a few funds that divide the portfolio allocation between mostly equity (at least 65%) and the remaining in debt or between domestic and international equity. For example, Equity Linked Savings Scheme (ELSS funds) is a tax-saving mutual fund that invests mostly in equity and equity-related schemes. ELSS funds help you save up to ₹1,50,000 annually in taxes.

Diversification - Diversification means that a fund is broken down and invested in different or 'diverse' portfolios. This means that your money will not go completely into one company or a certain type of company in the stock market. Why? Because if that company experiences losses, your entire investment will be at risk.

So, it is important that your money is invested in a diversified portfolio which is exposed to different sectors of the economy. The phrase 'don't put all your eggs in the same basket can be used to describe the meaning of diversification.

Risk Mitigation - Since equity mutual funds' corpus is evenly spread over different stocks, it also spreads the associated profits and risks. When one stock declines, the others may gain. Also, if one sector is plunging, the other may balance the portfolio, thus reducing the overall loss incurred. They lower the stock and sector-specific risk to a huge extent due to the investor not being dependent on one stock or sector.

Inflation-Adjusted Returns - When you compare equity mutual funds with traditional investment avenues, the former has the potential to generate better inflation-adjusted returns as the returns are market-linked. Equity funds offer opportunities to reasonably grow investors' capital over the long term.

Expert Management - Mutual funds are professionally managed by analysts who have experience and expertise in investment management. When it comes to mutual funds, you don't have to sit down and research where you should be putting your money because there are experts who are doing the research for you. You can rest easy knowing that the fund managers will do their best to get higher returns.

Cost-Efficient - Equity funds are cost-efficient as you can own shares in several companies via small investments without a high capital requirement. If you purchase stocks in big companies, it would burn a hole in your pocket. Hence, equity mutual funds provide economies of scale by making you a participant investor in different companies than what you could have done individually.

Also, you can invest in equity mutual funds via SIP (Systematic Investment Plan) and with this mode, you can start your investing journey for as low as ₹100 per month. Also, you can invest in mutual funds via the lumpsum mode. If you have received a bonus or tax return and looking for the perfect investment avenue, the lumpsum mode has got you! In this mode, you can make a one-time investment and see it grow.

Tax-Efficient - Equity funds are taxed at 10% for long-term capital gains and 15% for short-term gains. However, if you invest in an ELSS (Equity Linked Savings Scheme) fund, you get the tax benefits under Section 80C of the Income Tax Act and you can get tax exemption up to ₹1.5 lakh. ELSS is the only tax-saving scheme with the lowest lock-in period (i.e.) 3 years, compared to other tax-saving schemes.

Since equity mutual funds have different types, they are suitable for any kind of investor - be it newbies or experienced investors.

If you are someone who wants to get started in stocks but doesn’t want to take too many risks, large-cap equity funds might be a good choice for you. These funds invest in the shares of the top-performing companies whose risk levels are low. These companies deliver stable returns over a long period.

If you are willing to take risks and looking to stay invested for the long term, you can consider investing in Multi Cap, Mid Cap or Small Cap Funds. These mutual funds offer higher returns and give you an opportunity to build a considerable amount of wealth over a period of time.

Here are some of the key factors you need to consider while choosing equity mutual funds.

Your investment goals may include planning for your kids' education, a down payment for your house, your children's marriage, your retirement, and more. The type of equity mutual fund you choose should depend on your goal - be it a short-term or long-term goal. Also, a clearly defined goal will help you estimate how much you need to invest for that goal. It is said to be a good idea to do investment in fixed income for short-term goals and in equity for long-term goals.

When you are investing in equity mutual funds, it is a good idea to stick to your area of expertise. Just because a certain sector is doing well doesn't mean you should rush to invest in it, as you might have limited knowledge about the field. Instead of investing further, stick to your investment capability and don't jump into a sector or a segment without having complete knowledge about it.

There are two types of risk appetites - risk capacity and risk tolerance.

Risk capacity is your actual capacity to take risks depending on your investment horizon, and age, among other factors. Meanwhile, risk tolerance is a person’s preference toward risk.

To learn more about this in detail, your risk capacity will be higher for long investment horizons because your investments will have sufficient time to recover from short-term volatility. You can take more risks when you are young because you have the time to save and invest. As you get older, your risk capacity will become low.

When it comes to risk tolerance, some investors are inherently more risk averse than others irrespective of their age/stage of life and financial situation. A person’s risk tolerance will also depend on their investment experience. For eg, new investors will have less risk tolerance than experienced investors who may have gone through multiple investment cycles.

If the market has been doing but the fund hasn't been performing well for a good while, it might not be a good equity mutual fund for you. Before investing, you can compare the performance of different funds online and find the one right for you.

Equity mutual funds are a good investment option for anyone looking to earn higher returns over the long term. If you wish to invest for the short term, you can consider investing in Large-Cap Mutual Funds. For your long-term goals, you can consider choosing Mid Cap, Small Cap, and Multi Cap Funds based on your risk tolerance.

It is always a good idea to figure out your risk tolerance, investment horizon, and investment goals before you choose the right mutual fund for you. Try learning as much as you can about mutual funds to make it easier for you to make informed decisions. You can read more about mutual funds in our Koshex Blogs section where we are breaking down complex concepts in simple terms.

If you are looking to start your investment journey in Equity Mutual Funds, head over to Koshex and within less than 60 seconds. You can create an account without doing any paperwork. You can also track expenses, budget your money, track your savings progress, invest in personalized recommendations, and more, with Koshex. Create an account today.