What are equity mutual funds? Meaning, Types and How to Invest

An equity mutual fund (EMF) is a viable investment option for those seeking short-term or long-term gains. It is a way to diversify your investment portfolio. If you are new to the world of mutual funds and want to invest in equity mutual funds, it is important to understand what they are, how they work, and their benefits.

At the same time, you should be aware of their risks. Here is the answer to all this and much more you need to know. There are plenty of investment options to help you secure your future. Of them all, equity mutual funds are some of the most rewarding choices.

The purpose could be anything, from income to growth or a combination of both. They give investors endless money-making opportunities. They also involve the events of losses. EMFs may result in considerable returns. However, it depends on the market trend and the time you buy and sell them.

What are Equity Mutual Funds?

An equity mutual fund scheme that allocates the maximum of its assets to equities stocks is known as an equity fund. The name equity mutual funds comes from the large concentration of equities, despite the small proportion invested in debt and other funds.

Professional fund managers manage these funds. Irrespective of whether you choose SIP or lump sum, the fund manager invests your money in various equity stocks of different companies based on the objectives of the underlying scheme. EMFs allow investors to participate in the stock market even with low investment.

Equity mutual funds involve both: the rewards of capital appreciation and the risk of loss. The gains and losses obtained in the portfolio affect your fund’s Net Asset Value. If you invest in equity funds wisely, you can create long-term wealth.

What are the benefits of equity mutual funds?

The benefits below make equity funds one of the feasible investment options to create long-term wealth. They are as follows:

Risk diversification

Equity mutual funds invest in a portfolio of stocks across various companies and industries, thereby providing risk diversification to the investor. This diversification across stocks and sectors minimizes the risk to a great extent.

Ideal for small investors

These funds work by pooling money from various investors, giving small investors an equal opportunity to gain capital appreciation. The minimum amount to invest in mutual funds is as low as Rs. 5000. If you seek long-term gains and want to invest via SIP, you can start with just Rs. 500.

Financial expertise is no barrier.

Investors do not necessarily need to be financially literate to invest in mutual funds. Even individuals with no expertise in the stock market can make money from mutual funds, thanks to expert fund managers who manage mutual fund schemes. These professionals analyze the stock market and track investment opportunities to generate superior returns for investors.

High liquidity

Open-ended mutual fund schemes, except ELSS, offer high liquidity. They allow investors to redeem their units partially or fully at any time. You can sell your MF units by sending a redemption request to the Asset Management Company. It is worth noting that redemption in the exit load period might attract charges.

Taxation Rules of Equity Mutual Funds

Capital Gains Tax

This is the most significant tax applicable to equity mutual funds.

a) Short-Term Capital Gains (STCG)

When it applies: If you sell your equity mutual fund units within 1 year of buying them.
Tax rate: You’ll pay 15% tax on the profit made.
No minimum limit: This 15% tax is charged on the entire profit, no matter how small or big it is.

b) Long-Term Capital Gains (LTCG)

When it applies: If you sell your mutual fund units after 1 year of holding them.
Tax rate: You pay 10% tax on profits above ₹1 lakh in a financial year.
Exemption: The first ₹1 lakh of profit each year is tax-free.
Grandfathering rule: If you bought units before 31 Jan 2018, the profit is calculated using the highest NAV on 31 Jan 2018 as your buying price (to protect old gains from being taxed).

2. Securities Transaction Tax (STT)

When it applies: When you sell (redeem) your equity mutual fund units.
Rate: 0.001% of the amount you get from selling.
Who pays: The mutual fund company deducts it automatically, so you don’t need to do anything.

3. Tax Deducted at Source (TDS) on Dividends

When it applies: If the total dividend you receive in a financial year exceeds ₹5,000.
Rate: 10% TDS is deducted automatically. If you don’t provide your PAN, the rate increases to 20%.
Tax credit: You can claim this TDS when you file your income tax return.

4. Taxation for SIPs (Systematic Investment Plans)

Each SIP installment is considered a separate investment.
So, the 1-year holding period is counted individually for each SIP date.
When you redeem, some units may be held for more than a year (LTCG applies), and others less than a year (STCG applies).
As a result, you might end up paying both short-term and long-term capital gains tax on different parts of the same SIP.

Types of Equity Mutual Funds

There are various types of equity mutual funds, each with its own way of choosing stocks and investment goals. Here’s an overview of the main types:

1. Large-Cap Funds

Large-cap funds are mutual funds that mainly invest in the shares of the top 100 biggest companies. These companies are well-known, financially strong, and have a long history of stable performance.

Because they are less affected by market ups and downs, large-cap funds are considered safer than those invested in smaller companies. While the returns may not be as high as riskier funds, they are usually more stable and reliable.

2. Mid-Cap Funds

Mid-cap equity funds invest in companies ranked between 101 and 250 based on their market value. These companies are not as large as the top ones but still have good chances to grow. They can give better returns than large-cap funds but also carry more ups and downs and higher risk.

3. Small-Cap Funds

These funds focus on companies beyond the top 250 in market capitalization. Small-cap stocks can give high returns but are very volatile. These funds are best fitted for people who can tolerate higher risk and are willing to stay invested over the long term.

4. Multi-Cap Funds

Multi-cap funds invest across large, mid, and small-cap funds. They offer diversification and flexibility, allowing fund managers to shift investments based on market conditions and opportunities.

5. Flexi-Cap Funds

Similar to multi-cap funds, flexi-cap funds can invest in companies of any size. However, they offer even more flexibility as they are not bound by any minimum allocation to large, mid, or small-cap segments, giving fund managers complete freedom.

6. ELSS (Equity Linked Savings Scheme)

These are tax-saving mutual funds that qualify for deductions under Section 80C of the Income Tax Act (up to ₹1.5 lakh). ELSS funds have a mandatory 3-year lock-in period and invest mainly in equities.

7. Sector Funds

Sector-specific equity funds invest in stocks from a particular sector, such as IT, pharma, banking, etc. While they can generate high returns during sectoral booms, they are risky if the sector underperforms.

8. Thematic Funds

These funds invest based on a theme, such as ESG (Environmental, Social, Governance), infrastructure, or consumption. While broader than sector funds, they still carry concentration risk if the theme doesn’t perform well.

9. Dividend Yield Funds

These funds focus on companies that have a consistent history of paying high dividends. They offer regular income along with capital appreciation, making them suitable for moderately conservative investors.

10. Focused Equity Funds

These funds invest in a limited number of stocks (usually up to 30). The concentrated approach may yield higher returns if the chosen stocks perform well, but limited diversification also increases risk.

11. Contra Funds

Contra funds invest against prevailing market trends. For example, they might buy undervalued or underperforming stocks that are expected to bounce back. These funds require patience and a contrarian approach to investing.

12. Value Funds

Value funds aim to invest in fundamentally strong companies undervalued by the market. They typically have a long-term investment horizon and focus on intrinsic value rather than short-term momentum.

How to invest in equity mutual funds?

Equity funds are a popular way to invest in the stock market and gain returns over the long term. Here is how to invest in equity mutual funds:

Start by setting your investment goals. Determine whether you want to invest for long-term wealth creation, retirement, or other financial objectives. With clear goals, you can choose the right funds and make sure-fire investment strategies.
Understand mutual funds and how they work. Learn about their types (large-cap, mid-cap, small-cap, and sector-specific funds), benefits, and risks associated with equity funds.
The next step requires choosing a trusted fund house with a good track record of managing equity funds. Consider long-term performance, the fund manager’s expertise, and the reputation of the fund house in the industry.
Select the right funds that fit with your investment plans and risk capacity. Invest in funds across different market segments and asset classes to diversify your portfolio and reduce the risk prospects.
Complete your KYC documents, such as proofs of identity, address proof, PAN, etc. Then open an investment account with a fund house or an MF distributor. You can do this via the fund house’s website or their app. Complete the registration by following the instructions and providing the necessary details, such as personal, banking, and financial.
Choose our investment mode by deciding whether you want to invest through a lump sum or SIP. The latter requires you to invest a fixed amount at a regular interval, i.e., monthly or quarterly.
Once your account is ready and KYC is verified, you can start making investments. Monitor and review the performance of your mutual funds and track how they align with your investment goals.

Conclusion

Investing in equity funds requires understanding more than what equity mutual funds are and their benefits. Investors seeking investment in equity mutual funds should assess their investment goals and risk tolerance. It is crucial to read the fund’s prospectus before making any decision. Also, you may consult with a financial adviser to create a potentially better fund investment strategy.