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 are purchasing units of a scheme that pools investments from numerous investors and invests in equity shares of multiple companies. This way, you can participate in the ownership of the listed companies with even 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 your wealth. This is because even if a particular stock from an equity fund portfolio fails to perform, others can offset the losses. However, investing 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, as mentioned below: 

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

1. 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.

2. 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.

3. Small Cap Funds

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

4. Multi Cap Funds

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

• 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.

1. Sectoral/Thematic Equity Funds - You can invest in a portfolio containing stocks from your preferred sector, like IT services, banking, agriculture, real estate or themes like PSU and services. The minimum required asset allocation is 80% in the chosen sector/theme.

2. 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.

3. Contra Equity Funds - Schemes in this category follow the contrarian investment strategy with at least 65% of the corpus invested in contra bets.

4. Value Equity Funds - These schemes follow the value investment strategy. The fund manager looks for stocks that are trading below their intrinsic or book value while using this strategy. The fund manager has to invest a minimum of 65% of the funds corpus in value stocks.

5. Dividend Yield Funds - These funds invest 65% of their assets in high-dividend yield stocks.

• Equity-linked Savings Scheme - These funds have a lock-in period of 3 years. The amount you invest in these funds are eligible for deduction under section 80C of the Income Tax Act. An ELSS has to invest at least 80% of its corpus in equity.

• Based on Fund Management

Equity mutual funds are sometimes categorised as per their management. Let us take a look at them: 

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?

Let us look at some of the advantages and disadvantages of investing in equity mutual funds:

What are the factors to consider when investing in equity funds?

Here are some essential factors that you must consider before investing in an equity fund:

• 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. You must select a type of fund and investment tenure that will help you fulfil your financial goals.

• Figure out your risk tolerance

Every individual has a distinct risk appetite. Hence, you should select the appropriate fund whose risk level you are comfortable with. You should also check the risk-reward ratio (RRR), which can help you compare the yield, excluding the liable charges, and if it fits your needs.

• 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. 

On the other hand, Short Term Capital Gains (STCG) are taxed at 15% for a holding period of less than a year. 

• 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.

However, if the dividend exceeds Rs. 5,000, you will be liable to pay 10% of the amount as TDS under section 194K.

• Check for the fund manager’s efficiency

Fund managers are responsible for allocating your funds across various equities. Therefore, it is essential to check the fund manager’s experience and expertise to determine their credibility. You can review the manager’s track record and investment pattern to check if it aligns with your interest.   

• Fund expenses 

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

• Research about the fund’s past performances

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

Equity mutual funds bring a lucrative opportunity for high returns and tax benefits. Furthermore, you will have various options per the market prospect and risk appetite. However, remember that equity investments carry high risks.