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What are equity funds?

When we say mutual funds, the perception among most people is that they invest in stocks. That’s not entirely true since there are funds that invest in fixed instruments as well, and they are known as debt funds. Nevertheless, when people say they invest in mutual funds, they do mean equity funds, since they are the most popular.

So what is an equity fund? Simply put, an equity fund is a mutual fund that invests in stocks for the benefit of investors. It’s a convenient way to invest in the stock market. This is because the funds are managed by professional fund managers, who have the expertise to buy and sell stocks at the right time in order to maximize returns for investors. Mutual funds also enable investors to buy in small quantities according to what they can afford.

Types of mutual funds

Now that you know what is an equity mutual fund, we can look at the various types of equity funds. Here are some of them:

  • Large-cap funds: Large-cap funds are those that invest in the stocks of large, well-established companies that have large market capitalisation. These mature companies offer steady returns and are considered a safe bet by conservative investors. Many also give out dividends that many investors find an attractive proposition.

  • Mid-cap funds: Mid-cap funds are those that invest in companies that are still in the growth phase. These stocks are more volatile than those of large-cap companies. They tend up to move up faster in a bull phase and fall harder in a bear market. Risks are on the higher side for these funds, but they may pay handsome returns in the long term.

  • Small-cap funds: Small-cap funds invest in companies in their infancy and new to the stock market. The degree of risk is higher here than in mid-cap funds, and as always, there is a correlation between risk and reward. Today’s small-cap could well be tomorrow’s large-cap.

  • Sectoral funds: Sectoral funds invest in companies that belong to a particular sector. For example, an FMCG fund will invest in the stocks of fast-moving consumer goods companies and a pharma fund will invest in drug companies. These funds are suitable for investors with higher risk appetite since there are dangers in putting all your eggs in one basket. A diversified fund is a better bet for conservative investors.

  • Hybrid funds: Hybrid funds invest in a mix of equity and fixed income instruments. These are suitable for investors who want the higher returns offered by equity but want to balance out the risk by having a fixed income component.

Benefits of investing in equity funds

There are many benefits to investing in equity funds. Here’s a look at some of them:

  • Easy for investors: Equity funds offer an easy way to invest in the stock market. You don’t have to study stocks in detail and figure out what to buy at that time.

  • High returns: Over the past few years, returns from equity have been higher than in most other asset classes, like gold, real estate or fixed income instruments. So if you want to get on to the equity bandwagon, you have to invest in mutual funds.

  • Diversification: You get the benefit of diversification when you invest in an equity fund. When you buy units of an equity fund, you get exposure to many more stocks than if you bought shares on your own. Let’s use an example to illustrate this. Let’s say you had Rs 6,700 to invest and decided to put your money in Infosys shares. You would get only 10 shares for that amount. If instead, you had invested the same amount in a diversified large-cap fund, you would have invested in not just Infosys, but Wipro, TCS, Reliance Industries and HDFC Bank as well. Your investment would have been much more diversified and thus your risk reduced considerably as well.

  • Professional management: Mutual funds are managed by professional fund managers with the necessary qualification and expertise to do the job of picking shares at the right time at the right price so that they maximize returns. It’s hard for a lay investor to get the timing right in the stock market since it means studying price movements for long periods of time.

  • Tax benefits: You can enjoy tax benefits by investing in equity funds. Under section 80C of the Income-Tax, you can get a tax deduction of Rs 1.5 lakh by investing in an Equity-linked Savings Scheme (ELSS). So when you invest in ELSS, you can reduce your taxable income by Rs 1.5 lakh! There is, however, a three-year lock-in period for the investment.

  • Reduced transaction costs: Since mutual funds buy and sell large volumes of stocks, they are able to enjoy economies of scale and thus reduce transaction costs. So when you buy units of a mutual fund, you are saving on transactions costs. Of course, you must remember that investing in mutual funds has its costs in the form of entry loads and expense ratios, which is what mutual funds charge for managing your investments.

  • Divisibility: The prices of some shares can be high, so investors may not be able to get many if they don’t have too much money to invest. By buying mutual funds, you can get around this problem.

  • Liquidity: One of the biggest benefits of investing in an equity fund is its high level of liquidity. You can redeem a mutual fund within two-four business days, depending on the type of fund.

  • Systematic Investment Plan (SIP): SIP is very convenient for investors who want to invest small amounts of money at regular intervals. You can choose how much to invest each month according to your ability and investment objectives. It introduces discipline in your investing, and you will be able to ride out the ups and downs of the stock market and make stable returns.

How to choose an equity fund

It’s not enough to what is an equity fund, you must also know how to choose one. Here are some pointers:

  • Risk appetite: You must remember that all mutual funds carry risks in varying degrees; some funds involve more risk than others. If you are a conservative investor looking for stable returns, your best option would be a diversified large-cap fund. On the other hand, if you are willing to take risks and enjoy higher returns, you could go in for mid-cap funds.

  • Make the right choice: There are many equity funds in the market, so you must do a careful comparison before investing in any one of them. The best way of doing it is by comparing returns. You should compare returns over several time periods – one, three or five years – and find one that performed the best during these periods. There are many websites and companies offering comparisons of mutual funds. The Angel BEE app offers comparisons of mutual funds to help you make the right choice. It has the ARQ hyper-intelligent investment engine for selecting the best mutual fund schemes.

  • Check the costs: Investing in mutual funds involves some costs. One is the entry load that mutual funds charge when you are buying into a scheme. Then there’s the expense ratio, which is what it charges you to manage your investments. The expense ratio is the amount that is used for management, marketing, and administrative expenses. A 1% ratio means that 1% of the fund’s total assets will be used for expenses. A high entry load and expense ratio will reduce your returns, so you have to make sure that you choose a fund that has the lowest figures.

  • Time frame: Time frame is important while you’re making your investment calculations. Stock markets move up and down in the short term, but the longer-term trend has generally been upward. So you have to be invested for the long term to reap the real benefits. Generally, a time frame of 10-15 years is ideal, but even five years should get you reasonably good returns. Younger people should put more of their money into equity funds. If you want to invest for the short term, a debt fund could be more suitable since returns are predictable.

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