What you need to know about equity funds?

Looking to invest? Here's why investing in an equity fund is a good option

What you need to know about equity funds?

An equity fund is a fund that invests the majority of the principal amount in equity shares of companies, and is also known as a stock fund. There are many types of equity funds. Let’s take a look at the ones that are commonly encountered in investment circles:

  • Sector funds – These are funds invested in a specific sector, such as healthcare, IT, FMCG, etc. They follow a particular theme and are more volatile in nature. Sector funds are considered to be a riskier type of equity fund as a good strength of the principal is invested in one particular sector.
  • Multi-cap equity funds – These are invested based on market capitalisation; large-cap funds are invested in the industry giants on the list, while medium- and small-cap funds are invested in medium- and small-sized companies respectively. Of these, returns on mid- and small-cap funds tend to fluctuate more. Since larger and more established companies offer more stability and reliability, their returns too are steadier.
  • Index funds – This type of equity fund is actively managed with continuous portfolio modification depending on the market scenario, but index funds are a more passive style of investing. They replicate or track market index components and provide a broad market exposure at a lower operational cost.
  • Equity-linked savings schemes (ELSS) – These offer a diversified portfolio, with the option of investing in different company sizes across sectors. As a tax-saving vehicle, ELSS has a significantly shorter lock-in period of just three years.

Related: How debt and equity-based mutual funds differ in risk 

Benefits of investing in equity funds

While it does require due diligence and ample research to understand and find success in investing in equity funds, it’s worth the effort when you weigh the benefits. Apart from being a great investment avenue for those with limited capital, it also provides these benefits:

  • Lower investment cost
  • Flexibility
  • Diversification
  • Systematic investment
  • Tax benefits (subject to choosing the correct type of equity funds to invest in)
  • Better money management

Related: How and when to de-risk one's investment portfolio 

How equity funds are taxed

One acquires capital gains on redeeming the equity funds held by them. This gain is taxable depending on the duration for which the capital was invested in the funds. This duration is known as the ‘holding period’.

Depending on the holding period, capital gains are classified as short-term or long-term. Gains earned on investments with a holding period of a year or less are classified as short-term gains, while those earned on a holding period of over a year are called long-term capital gains. 

As per the modification made in the Budget 2018, the long-term capital gains of over Rs 1 lakh on listed equity shares (in a given financial year) is taxable at the rate of 10% without the benefit of indexation. The best tax-saving equity fund option is ELSS, where you can get a deduction of up to Rs 1.5 lakh under Sec. 80C and save up to Rs 45,000 in taxes.

Related: Equity Mutual Funds vs Stocks: Where to invest? 

Performance of equity funds in India

Although the returns vary both from the micro-perspective of the current market and the macro view of the economic conditions in India, equity funds have shown the highest before-tax returns (10% - 12%) when pitted against other mutual fund categories.

Who should invest in equity funds

Equity funds, owing to the diverse availability of options, can be a great investment choice. The guiding factors are essentially having a good risk appetite and readiness to lock in the capital for at least five years. A shorter investment period may not generate good returns because of the volatility of the market. 

Related: Clueless about investing in stock markets? Here are some options 

That said, ELSS not only comes with a shorter lock-in period (three years) but also provides better returns when compared with other tax saving instruments under Section 80C.

If you’ve just entered the market, large-cap funds are a better bet as established companies usually provide better and more stable returns. However, if you have decent market knowledge and want to play the field a little by taking calculated risks, a diversified equity funds profile (with investments in different companies of varying sizes) should yield higher returns.

Investing in equity funds definitely calls for a deeper understanding of the market and requires one to choose the correct portfolio, but in view the kind of returns it generates, equity funds should be an important part of every investment portfolio.

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