Guide to Investing in Equity Mutual Funds

Investing in equity can be a risky deal. However, it has the potential to yield high returns. Consider investing in equity mutual funds, which can help diversify your investments and reduce risks. This article provides a comprehensive guide to equity mutual fund investing to help you kickstart your investments efficiently.

What Are Equity Mutual Funds?

Mutual funds help you diversify your investments. By investing in equity mutual funds, you purchase units of a scheme that pools investments from numerous investors and invests in equity shares of multiple companies. This allows you to participate in the ownership of listed companies with a small investment amount.

Fund managers are responsible for allocating the funds and framing the equity mutual fund’s portfolio. The overall returns from such mutual funds depend on the performance of individual stocks.

Mutual funds are widely preferred for long-term investments to build wealth. This is because even if a particular stock from an equity fund portfolio fails to perform, others can offset the losses. However, investing in equity mutual funds is subject to market risks.

What Are the Types of Equity Mutual Funds?

Equity mutual funds can be divided into four categories:

1. Market Capitalisation

Based on market capitalisation, equity funds can be divided into:

Large Cap Funds

These mutual funds invest at least 80% of their total assets in the equity shares of large-cap companies or the top 100 companies listed on Indian stock exchanges in terms of market capitalisation.

Mid Cap Funds

A mid-cap mutual fund scheme allocates a minimum of 65% of its total corpus to mid-cap stocks, which fall between 101 to 250 based on their market capitalisation.

Small Cap Funds

Small-cap mutual funds are open-ended equity schemes investing a minimum of 65% of their total corpus in small-cap companies ranked 251 or higher.

Multi Cap Funds

A multi-cap fund invests across market capitalisations, i.e., large-cap, mid-cap, and small-cap companies.

2. Investment Strategy

You may be inclined towards a particular theme of investment, be it a sector, industry, or any other investment theme. In that case, you can select the following equity mutual fund categories:

Sectoral/Thematic Equity Funds

Invest in a portfolio containing stocks from your preferred sector, such as IT services, banking, agriculture, or real estate. The minimum required asset allocation is 80% in the chosen sector/theme.

Focused Equity Funds

These schemes focus on a certain number of stocks. The fund manager can invest in up to 30 stocks by allocating a minimum of 65% of the scheme’s corpus in equity and equity-related instruments.

Contra Equity Funds

Schemes in this category follow the contrarian investment strategy, with at least 65% of the corpus invested in contra bets.

Value Equity Funds

These schemes follow the value investment strategy, where the fund manager looks for stocks that are trading below their intrinsic or book value. The fund manager has to invest a minimum of 65% of the fund's corpus in value stocks.

Dividend Yield Funds

These funds invest 65% of their assets in high-dividend yield stocks.

Equity-Linked Savings Scheme (ELSS)

These funds have a lock-in period of 3 years, and the amount you invest is eligible for deduction under section 80C of the Income Tax Act. An ELSS must invest at least 80% of its corpus in equity.

3. Based on Fund Management

Equity mutual funds are sometimes categorized as per their management:

i. Passive Funds

Equity funds that mimic market indices and do not require extensive research and supervision from fund managers are said to be passive funds.

ii. Active Funds

In contrast, portfolios containing researched and hand-picked stocks are considered active funds.

What Are the Advantages and Disadvantages of Investing in Equity Funds?

Advantages

• Equity funds can generate higher returns than other funds or investment options like debt funds, bonds, and fixed deposits.
• Equity mutual funds have a diversified portfolio containing stocks across multiple sectors or market caps, allowing for good diversification.

Disadvantages

• Although mutual funds offset losses somewhat, the equity market is highly volatile. Hence, any mismanagement may lead to loss.
• Equity funds charge high fees for managing and maintaining stock portfolios, making the intrinsic cost of investing in equities high.

What Are the Factors to Consider When Investing in Equity Funds?

Here are some essential factors to consider before investing in an equity fund:

1. Determine Your Investment Goals

Equity mutual funds are known to generate high returns over a long period. Hence, it is considered a long-term investment. Select a type of fund and investment tenure that aligns with your financial goals.

2. Figure Out Your Risk Tolerance

Every individual has a distinct risk appetite. Choose a fund whose risk level you are comfortable with. Additionally, check the risk-reward ratio (RRR) to compare yields, excluding applicable charges, and see if it fits your needs.

3. Tax on Equity Funds

Equity funds attract long-term and short-term capital gains taxes. Long-Term Capital Gains (LTCG) are applicable when you hold your fund units for at least one year. If the long-term capital gains exceed Rs. 1 lakh, you will be liable to pay 10% of your gains in taxes.

Short-Term Capital Gains (STCG) are taxed at 15% for a holding period of less than a year.

4. Tax on Dividends

Mutual funds offer a dividend payout option where dividends are declared when the fund makes significant profits. Taxes on mutual fund dividends are added to an investor’s income for taxation purposes and taxed as per their applicable tax slab. If the dividend exceeds Rs. 5,000, you will be liable to pay 10% of the amount as TDS under section 194K.

5. Check for the Fund Manager’s Efficiency

Fund managers allocate your funds across various equities. It is essential to check their experience and expertise to determine their credibility. Review the manager’s track record and investment pattern to ensure it aligns with your interests.

6. Fund Expenses

Equity funds involve various charges, including the expense ratio and an exit load applicable for redemption within a specific time. Conduct a thorough cost-benefit analysis to check if the fees are reasonable and do not significantly impact your overall returns.

7. Research About the Fund’s Past Performances

Checking a fund’s market performance over previous years is crucial. This helps you determine if the returns are consistent and if they align with your financial goals. Also, compare a particular fund’s returns against other funds in the same category.

Equity mutual funds present a lucrative opportunity for high returns and tax benefits. You will have various options based on market prospects and risk appetite. However, remember that equity investments carry high risks.