Best Equity Funds
3Yr. Returns
5Yr. Returns
 

Equity Fund : Basics, Types, Benefits and More

Updated on

The popularity of equity investments is rising, and there are more discussions and comparisons around them now. No other investment avenue offers scope for such high returns as equity funds. Get answers to all your questions and doubts here through the following topics.

  1. What is an Equity Fund?
  2. How do Equity Funds work?
  3. Who should invest in Equity Funds?
  4. What are the types of Equity Funds?
  5. Features of Equity Funds?
  6. Performance of Equity Funds in India
  7. Benefits of investing in Equity Funds
  8. Taxation of Equity Funds
  9. SIP – The best way to invest in Equity Funds

 

1. What is an Equity Fund?

Equity funds aim to generate high returns by investing in the shares of companies of different market capitalisation. They produce higher returns than debt funds and fixed deposits. The performance of the company decides the investors’ returns.

2. How do Equity Funds work?

An equity fund invests at least 60% of its assets in equity shares of companies in varying proportions. This should be in line with the investment mandate. It might be a purely large-cap, mid-cap, or small-cap fund or a mixture of market capitalisation. Moreover, the investing style may be value-oriented or growth-oriented.

After allocating a significant portion of equity shares, the remaining amount will go into debt and money market instruments. This is to take care of sudden redemption requests as well as bring down 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.

3. Who should Invest in Equity Funds?

Your decision to invest in equity funds must align to your risk tolerance, investment horizon, and goals. Generally, if you have a long-term goal (say, five years or more), it is better to go for equity funds. It will also give the fund ample time to ride out the market fluctuations.

a. For budding investors

If you are a budding investor who wants to have exposure to the stock market, then large-cap equity funds may be the right choice. These funds invest in equity shares of the top 100 companies in the stock market. The well-established companies have historically delivered stable returns over the long-term.

b. For market savvy investors

In case you are well-versed with the market pulse but want to take calculated risks, you may think of investing in diversified equity funds. These invest in shares of companies across market capitalisation. These give an optimum combination of high return and lesser risk as compared to equity funds that only invest in small-cap/mid-caps.

 

Equity Funds

4. Features of Equity Funds

a. 80C tax exemption

ELSS is the only tax-saving investment under Section 80C of the Income Tax Act that gives you equity exposure (other than NPS). With its shortest lock-in period of three years and high return potential, ELSS has a good track record . You can invest in small but regular instalments or a lump sum as per your affordability.

b. Cost of investment

The frequent buying and selling of equity shares often impact the expense ratio of equity funds. Currently, SEBI has fixed the upper limit of expense ratio at 2.5% for equity funds and is planning to reduce it further. A lower expense ratio, of course, translates into higher returns for investors.

c. Holding period

When you redeem units of equity funds, you make capital gains. The capital gains are taxable in the hands of investors. The rate of taxation depends on how long you stay invested in equity funds, and this period is called the holding period.

d. Cost-efficiency & diversification

By investing in equity funds you can get exposure to a number of stocks by investing a nominal amount.

For instance, if you have Rs 2,000 to invest, then you will be able to buy one stock of a large-cap company or one stock of 2-3 mid-cap companies. However, your portfolio will face concentration risk. But with the same amount, you can get exposure to a lot many stocks when you invest in equity funds. This allows you to diversify and benefit meaningfully.

5. Types of Equity Funds

You can categorise equity funds based on their investment mandate and the kind of stocks and sectors they invest in.  

a. Based on Sector and Themes

Equity funds that focus their investments on a particular sector or theme fall under this category. Sector funds invest in a specific industry such as FMCG or Pharma or, Technology. Thematic funds follow one specific subject such as emerging consumer companies or international stocks.

Since sector funds and thematic funds focus on a particular sector or theme, they tend to be riskier. This is because of their performance face sectoral as well as market risks. However, industry and thematic funds can be diversified in terms of market capitalisation.

b. Based on Market Capitalisation 

Large-cap equity funds: Typically, large-cap companies are well-established, making them large-cap funds stable and reliable investments.

Mid-cap equity funds: They invest in medium-sized companies.

Mid-and-small-cap funds: There are even funds that invest in both mid-cap as well as small-cap funds. 

Small-cap funds: Since smaller companies are prone to volatility, small-cap funds deliver fluctuating returns.

Multi-cap funds: Equity funds that invest across market capitalisation, which is in large-cap, mid-cap, and small-cap stocks, are called multi-cap funds.

C. Based on Investment Style 

All the funds discussed above follow active investing style, wherein the fund manager decides the portfolio composition. However, there are funds whose portfolio composition imitate a specific index.

Equity funds that follow a particular index are called index funds. These are passively-managed funds that invest in the same companies, in the equal proportions, making up the index the fund follows.

Example, a Sensex index fund will have investments in all 30 Sensex companies in the same proportion in which the companies form part of the index. Index funds are low-cost funds as they don’t require the active management of a fund manager.

6. Performance of Equity Funds in India

Amongst all other categories of mutual funds, equity funds generally deliver the highest returns. On an average, equity funds have generated before-tax returns in the range of 10% to 12%. These returns may fluctuate as per market movements and overall economic conditions.

To earn returns in line with your expectations, you need to choose your equity funds carefully. For that, you have to strictly follow the stock markets and possess knowledge of the quantitative and qualitative factors. ClearTax assists by handpicking the top-performing investment portfolios for you, which suits your financial goals.

Invest in the Best Mutual Funds

Invest in 7 Mins | Free | 100% Online | Easy to Use | Safe

 

7. Benefits of Investing in Equity Funds

The benefits of investing in mutual funds are many:

a. Expert money management

b. Low Cost

c. Convenience

d. Diversification

e. Systematic investments

f. Flexibility

g. Liquidity

The primary benefit of investing in equity funds is that you don’t need to worry about choosing stocks and sectors to invest in. Successful equity investing requires a lot of research and knowledge. You need to dig deep into the financials of a company before you invest in it.

You also need to have an understanding of how a particular sector is expected to perform in the future. Of course, all of this requires a lot of time and effort, which most common investors don’t have. Hence, the solution is to leave the stock-picking to an expert fund manager by investing in an equity fund.

 

8. Taxation of Equity Funds

Capital gains earned on the holding period of up to one year are called short-term capital gains (STCG) and are taxed at the rate of 15%.

Conversely, capital gains made on holding more than one year are called long-term capital gains (LTCG). Owing to the changes in Union Budget 2018-19, LTCG over Rs 1 lakh will be taxed at the rate of 10%, without the benefit of indexation.

9. SIP or lumpsum- which is better? 

a. Lump-sum

If you can afford to invest a lump sum in one go per annum, this method too can work overtime. However, not everyone finds it feasible to arrange for a large sum and hence, opts for SIPs instead.

b. Systematic Investment Plan (SIP)

A SIP is usually a monthly investment that happens automatically on a pre-decided date. You give a mandate to the fund company to deduct the investment from your bank account.

SIPs give you the benefit of rupee cost averaging. This means that when the markets are high, you will be allotted fewer units. And when the markets are low, you will get more units for the same amount. This way, you invest at different levels of the market. SIPs also inculcate financial discipline and make mutual funds affordable for all.

Click here to start a SIP in equity mutual funds.

 

Invest in the Best Mutual Funds

Invest in 7 Mins | Free | 100% Online | Easy to Use | Safe