What Are Equity Funds in India? A Beginner’s Guide

Equity mutual funds are investment schemes that primarily invest in shares of listed companies across sectors and market sizes. As per SEBI guidelines, an equity mutual fund must invest at least 65 percent of its total assets in equities and equity-related instruments. This classification helps investors clearly understand the nature and risk profile of the fund they are investing in, while also bringing uniformity across fund categories.

These funds work by pooling money from multiple investors and investing it through a professionally managed portfolio. The fund manager selects stocks based on the fund’s objective, such as growth or stability, while investors hold units that reflect their share in the overall portfolio.

• Investment Concentration: Most of an equity mutual fund’s resources will be allocated towards the equity of publicly traded corporations, with traditionally over 65 percent of total assets tied up in equity.
• Return Expectation: Equity funds are designed primarily for capital growth over the long term, so when considering equity funds for long-term growth, the risk/return relationship must be carefully evaluated to determine if the potential upside outweighs the lack of performance assurance like other investment types.
• Fluctuating Return Risk and Volatility: Since equity funds are held on the stock exchange, investment returns can be volatile in the short term, which adds additional risk compared to fixed-income type investments.
• Asset Management by Professionals: Fund managers in equity mutual funds typically have extensive experience with analysing a company, a market, and/or the general economics’ performances before making investment decisions.
• Asset Diversification: When investing in an equity fund, a portion of that fund will be invested in multiple publicly traded companies operating in multiple industry sectors (or markets) to reduce the overall risk associated with investing solely in the performance of one individual company.
• Liquidity of the Fund: Like other mutual fund investments, an investor can generally purchase or redeem his/her shares at their current NAV, which is the same as a mutual fund share value.
• Investment Horizon: Since equity funds provide long-term capital growth opportunities, they might be suitable for those looking to invest for longer time periods (5-10 years and beyond).
• Investment Choices: Equity mutual funds are available in several varieties, such as large-cap funds, mid-cap funds, and sector or industry focused funds. This allows investors to choose options that best align with their risk tolerance and investment preferences.

Equity Funds Classified by Market Capitalization:

• Large-Cap Equity Mutual Funds: These invest in firms with market capitalizations ranging from 1 to 100. They are relatively less risky and may provide stability with potential long-term returns.
• Mid Cap Equity Fund: These funds make investments in firms rated 101 to 250. They are less risky than small-cap funds but may have greater potential for growth than large cap equity funds.
• Small Cap Equity Fund: Invest in firms with a market capitalization which rank greater than 250. These may have a higher risk, and higher potential returns.
• Large- and Mid Cap Equity Funds: These funds divide the equity allocation between mid- and large cap equity firms for a well-balanced combination of potentially strong returns and aims to achieve stability.
• Multi-Cap Equity Mutual Funds: These funds invest in equities of all market capitalizations, with minimum 25% allocation to large, mid and small caps each. This may be suitable for broad market exposure.

Equity Funds Classified by Investment Styles:

• Active Management: Most equity funds are actively managed, with portfolio decisions made by the fund management. 
• Passive Management: Index mutual funds, on the other hand, such as those following the Nifty50 or Sensex, are passive and replicate index composition. Because of the lesser management, these have a lesser TER (Total Expense Ratio).
• Sectoral Funds: These equity funds specialise in certain industries or sectors such as pharma, FMCG, technology, or infrastructure. The success of these designated industries or sectors has a strong influence on potential returns.

Equity mutual funds are further classified depending on a number of characteristics. For starters, they are frequently grouped based on the size of the enterprises in which they invest. Some funds concentrate on large cap firms, which are well-known and established corporations with substantial market capitalisations. Others focus on mid cap firms or small-cap firms, which are often smaller and may have more room for development. The fund’s investment strategy and risk profile are reflected in the size of the firm.

Advantages of Equity Mutual Funds

1. Diversification

Diversification is a basic risk-mitigation approach used by equity mutual funds. These funds avoid overexposure to any single company or industry by diversifying their assets across many equities and sectors. This conservative strategy serves as a buffer against rapid market shocks that might affect individual stocks or sectors owing to a variety of variables. Equity fund investment is a strategic choice for those seeking to participate in the potential growth of companies within a diversified portfolio.

2. Flexibility

Investors may pick from a variety of equity mutual funds, including large-cap, mid cap equity fund, small-cap, and sector-specific funds, allowing them to match their investments to their risk tolerance, financial goals, and investment horizon.

3. SIP

Equity mutual funds provide the convenience of SIP. Equity SIP allows investors to contribute modest, regular sums at defined times. This methodical approach makes investment more affordable and helps to potentially maximize the power of compounding over time.

4. Tax Advantages

Investing in Equity-Linked Savings Schemes (ELSS) provides an appealing opportunity for tax savings. The only type of mutual fund eligible for tax deductions under Section 80C of the Income Tax Act of 1961 is an ELSS fund or an equity-linked savings program. By investing in ELSS mutual funds, you may get a tax rebate of up to Rs 1,50,000 and save up to Rs 46,800 in taxes every year. This implies that your ELSS investment can be deducted from your taxable income, thus lowering your tax. Furthermore, mutual fund investments in general, including ELSS, provide tax benefits when held for a lengthy period of time.

Disadvantages of Equity Mutual Funds

1. Capital Gains Taxation

Equity mutual funds are subject to long and short-term capital gains. STCG Tax, if you redeem equity mutual fund units within one year after investing, the profits are termed short-term capital gains. These are taxed at a higher rate, which reduces your overall profits. While LTCG on stock mutual funds is lower than STCG, it is not completely tax-free. According to current tax legislation, LTCG on equity funds that surpass a certain threshold are taxed at a rate of 10%. This tax may have an influence on after-tax returns.

2. Exposure to Risk

Equity mutual funds are naturally vulnerable to market volatility. Depending on market conditions, the value of your investments might grow or decline dramatically. Because of this risk, equity funds may be inappropriate for investors with limited risk tolerance.

3. Longer Investment Horizon

While equity funds may deliver good long-term returns, they may not be appropriate for short-term financial goals. These funds are primarily focused on medium to long-term goals, making them less liquid for consumers who want immediate access to their money.

If you are looking to build an investment portfolio in the next ten to twenty years, equity mutual funds can be a good option for you. They offer exposure to a wide range of companies across sectors, which would be difficult for most individual investors to manage on their own. By investing through a mutual fund, you benefit from professional research and disciplined investing without having to track markets daily.

These funds are often considered for goals that are several years away, such as wealth creation or inflation-beating growth over time, while accepting that short-term market movements are part of the journey. Equity mutual funds also provide flexibility through options like SIPs and easy liquidity, making them accessible for investors who prefer a structured and gradual approach to equity investing.

In India, equity mutual funds are taxed based on how long you hold the units before selling them. If you sell your units within 12 months, any profit is treated as short-term capital gains and is generally taxed at 20 percent plus applicable cess. If you hold the units for more than 12 months, the profit is treated as long-term capital gains. Long-term gains are taxed at 12.5 percent on the amount exceeding ₹1.25 lakh in a financial year; gains up to that limit are typically exempt.

Dividend income from equity mutual funds is added to your total income and taxed according to your income tax slab rate. If the dividends you receive in a year exceed ₹5,000, a 10 percent TDS may be deducted by the fund house.

These tax rules apply to residents and are subject to change with annual budgets and tax laws, so it helps to check the latest notifications when planning your investments.

New Investors

• Complete KYC first: You must become KYC (Know Your Customer) compliant before you can invest. This usually involves submitting your identity and address proofs and verifying them.
• Define your goals: Think about why you are investing, your time horizon and how much risk you can handle.
• Pick a route to invest: Decide whether to invest via an online platform, a distributor or directly with a fund house.
• Choose funds carefully: Look at the type of equity fund, expense ratio, and how it compares with peers before you decide.
• Start with SIP or lumpsum: A systematic investment plan (SIP) helps you invest a fixed amount regularly, which many new investors find helpful. 

Seasoned Investors

• Revisit your goals and risk tolerance: As your financial situation changes, adjust your allocations between different equity funds.
• Analyse fund performance: Compare funds against benchmarks and peers over multiple years to inform your decisions.
• Diversify within equity: Consider mixing large-cap, mid-cap or other sub-categories to spread risk.
• Monitor and rebalance: Periodically review your portfolio and rebalance if your target allocations drift too far from your plan.
• Stay updated: Keep an eye on market trends, regulatory changes and taxation rules to make informed choices.

Equity mutual funds offer a simple way for many Indians to participate in the stock market with professional management and built-in diversification, which can help reduce the burden of picking individual stocks. While they are suited to longer investment horizons, it is important to remember that market movements can influence the value of your investments, and there are no guaranteed outcomes. Understanding your financial goals, risk tolerance and tax implications can help you choose funds that align with your plan. With thoughtful research and regular review, equity mutual funds can be a valuable part of a balanced investment strategy.