Introduction
Equity funds have long been a popular investment choice for long term wealth creation, evolving significantly since the inception of mutual funds in India. Choosing the right equity fund can be challenging, as a wide array of options are available. However, you can make more informed decisions with a clear understanding of the types of equity funds and their respective benefits.
What Is Equity Mutual Funds?
As their name implies, equity mutual funds generally invest in equities of different companies. These funds aim to bring higher returns by diversifying investments across various sectors and companies with varying market capitalisations. Unlike debt-based funds or term deposits, equity funds generally offer the potential for better returns. These funds do, however, come with some risk because their performance is highly dependent on the market's ups and downs.
Key Features of Equity Mutual Funds
Equity mutual funds have distinct characteristics that differentiate them from other mutual funds. They typically invest more than 60% of their assets in equity shares. Depending on the scheme's objectives, the remaining assets may be allocated to debt securities or money market instruments. The performance of these funds is heavily influenced by market trends and the strategic decisions of the fund managers, who may adopt either a growth-oriented or value-oriented approach.
Types of Equity Mutual Funds
Equity mutual funds can be categorised based on several factors, including investing strategy, market capitalisation, tax treatment, and investment style. Understanding these categories can help you choose the most suitable fund for their financial goals.
1. Investment Strategy-based Categorisation:
· Thematic or Sectoral Funds: These funds focus on a specific investment theme, such as international stocks or emerging markets. Alternatively, they could focus on an industry such as IT, pharmaceuticals, or BFSI (Banking, Financial Services, and Insurance). While these funds may offer high returns, they also come with higher risks due to their concentrated investment focus.
· Focused Equity Funds: These funds invest in a limited number of stocks, typically no more than 30, from companies with specific market capitalisations. This focused approach aims to maximise returns by concentrating on select high-potential stocks.
·Contra Equity Funds: Contrarian by nature, these funds invest in underperforming stocks with the expectation that they will recover and provide substantial returns in the long term.
2. Market Capitalisation-based Categorisation:
· Large-cap Funds: These funds invest in well-established companies with large market capitalisations. While they are generally considered safer, the returns might be moderate.
· Mid-cap Funds: These funds target medium-sized companies and offer a balance between risk and return, with the potential for significant growth.
· Small-cap Funds: These funds focus on smaller companies with great growth potential, but they also carry a larger risk than large-cap funds.
3. Tax Treatment-based Categorisation:
· Equity Linked Savings Scheme (ELSS): ELSS is the only equity mutual fund that provides tax advantages under the Income Tax Act's Section 80C. These funds have a three-year mandatory lock-in period and invest at least 80% of their assets in equity-related securities.
· Non-Tax Saving Equity Funds: Unlike ELSS, other equity funds do not offer tax savings and are subject to capital gains tax.
4. Investment Style-based Categorisation:
· Active Funds: These funds are actively managed by fund managers, and they rely on the expertise of the manager to select stocks that are expected to perform well.
· Passive Funds: These funds track a specific market index or segment with little to no active stock selection by the fund manager.
How Do Equity Mutual Funds Work?
Mutual funds that invest in different companies' equities aggregate several participants' money. The fund manager's role is crucial in determining the investment strategy, whether it’s focusing on growth or value stocks. The fund's success largely depends on the manager's ability to navigate market conditions and select the right mix of equities.
Investment Considerations for Equity Mutual Funds
It is important to evaluate your investment horizon, risk tolerance, and financial goals prior to purchasing equity mutual funds. If you are a new investor, equity funds can be an attractive option for entering the stock market without needing extensive capital or expertise. However, choosing funds based on your long-term goals and risk appetite is advisable.
If you are a seasoned investor, understanding the nuances of different equity funds may lead to better investment decisions and higher returns. You can leverage their market knowledge to select funds that align with their financial strategies.
Why Invest in Equity Mutual Funds?
Equity funds have the potential to yield better returns than alternative low-risk investments. They are particularly beneficial for wealth creation and portfolio diversification. Additionally, they hedge against inflation and can outperform fixed-return investment plans over time.
Taxation of Equity Mutual Funds
Mutual funds that own equity are liable to capital gains tax. Short-term capital gains (STCG), applicable if the fund is held for up to one year, are taxed at 15%. Long-term capital gains (LTCG) are taxed 10% without indexation benefits, applicable only to gains exceeding Rs. 1 lakh.
Conclusion
Equity mutual funds are a flexible investment option that may accommodate a broad range of financial objectives and risk tolerances. You can choose wisely and in line with their financial goals if they are aware of the many types of equity funds and their benefits.
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