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What is Equity Mutual Fund: Meaning, Types & Benefits

Equity Mutual Funds pool money from different investors to invest primarily in stocks of various companies and offer diversification, professional management, and the potential for higher returns.

  • 6,443 Views | Updated on: Oct 08, 2024

Equity mutual funds have emerged as a popular and effective investment vehicle, offering a balance between risk and potential returns, making them an attractive choice for investors seeking long-term wealth creation. Let us understand what is equity fund, how it works, and its types.

What are Equity Funds or Equity Mutual Funds?

As an investor, you often come up with questions like what are mutual funds or equity mutual funds? Equity mutual funds are popular investing options that offer long-term wealth, making them an excellent investment alternative for capital appreciation. Equity-oriented mutual funds are a great option for long-term investors who wish to get their feet wet in the stock market.

How Does Equity Mutual Fund Work?

Now that you know what is equity mutual fund, let us understand how it works. Equity mutual funds are a popular way to invest in the stock market without the hassle of picking individual stocks. Think of them like a big pot where many investors pool their money together. This pot of money is then managed by professional fund managers who use it to buy shares in various companies. The goal is to grow the fund’s value by investing in companies expected to perform well. When these companies do well, the value of their shares goes up, and so does the value of the mutual fund.

This increase in value is reflected in the Net Asset Value (NAV) of the fund, which is essentially the price per share of the mutual fund. Investors can buy or sell mutual fund shares based on this NAV. It’s a way to benefit from the potential growth of the stock market while spreading out the risk since the fund invests in a diversified portfolio of stocks. Plus, it’s managed by experts who make decisions based on research and market analysis, which can be a big plus for those who don’t have the time or expertise to manage their own stock portfolios.

Types of Equity Mutual Funds

Investors can invest in a range of hybrid mutual funds. The choice of the plan should be determined by the investor’s investment aim, risk profile, and investment horizon. The broad classes of equity funds include:

Large Cap Equity Funds

Large-cap funds invest primarily in firms with a high market capitalization. These companies are typically well-established, stable, and have a proven track record. Large-cap funds are less volatile than mid-cap or small-cap funds, making them suitable for conservative investors seeking stable long-term growth. These funds may also provide regular dividends.

Mid-Cap Funds

Mid-cap funds invest in companies with a medium-sized market capitalization. These companies are often in a growth phase, which presents an opportunity for investors to benefit from potential capital appreciation. Mid-cap funds can be more volatile than large-cap funds but offer a balance between stability and growth potential. These funds are appropriate for investors with moderate risk tolerance.

Large and Mid-Capitalization Funds

Big and mid-cap funds invest a minimum of 35% of their assets in both large-size (top 100 firms based on market capitalization) and mid-cap enterprises (101-250 companies in terms of market capitalization). The remaining 30% of the assets may be invested in shares other than big and mid-size, debt and money market instruments and other SEBI-approved securities.

Small Cap Equity Funds

Small-cap funds focus on companies with a small market capitalization. These companies are often in the early stages of growth or operate in niche markets. Small-cap funds are more volatile and carry higher risks than large-cap and mid-cap funds. However, they also have the potential for substantial capital appreciation over the long term. Small-cap funds suit investors with a high-risk tolerance and a long investment horizon.

Sector Funds

Sector funds concentrate their investments in a specific sector or industry. These funds allow investors to target a particular sector they believe will outperform the broader market. For example, sector funds are dedicated to technology, healthcare, energy, financial services, and more. Sector funds can be more volatile than diversified equity funds as they are exposed to sector-specific risks.

Thematic Equity Funds

Thematic equity funds are specialized mutual funds that invest in stocks based on a specific theme or trend. Instead of focusing on a particular industry or sector, these funds target companies that align with a broader concept, like technology innovation, renewable energy, healthcare advancements, or even demographic trends like aging populations. The idea is to capitalize on long-term growth potential by investing in companies expected to benefit from these themes.

International Equity Funds

International equity funds are mutual funds that invest in stocks of companies based outside the investor’s home country. The primary goal of these funds is to diversify the investment portfolio geographically, which can reduce risk and offer exposure to growth opportunities in global markets. Investing in international companies can benefit from economic growth in different regions, which may only sometimes correlate with their home country’s market. These funds can focus on developed markets, emerging markets, or a combination of both.

Index Equity Funds

Index equity funds, also known as index funds, aim to replicate the performance of a specific stock market index. These funds invest in the same companies that make up the chosen index in the same proportions. The main advantages of index funds are their simplicity and cost-effectiveness. Since they are passively managed, they usually have lower fees than actively managed funds. The goal of an index fund is not to outperform the market but to match its performance.

Benefits of Equity Mutual Funds

Investing in mutual funds has long been recognized as a popular and effective means of growing wealth. Among the various types of mutual funds, high-return equity mutual funds have garnered significant attention and have proven to be a valuable tool for investors seeking long-term capital appreciation.

Diversification

Equity mutual funds offer investors the advantage of diversification. By pooling money from numerous investors, these funds can be invested in various stocks across various sectors and industries. This diversification helps reduce the impact of individual stock volatility and spreads the risk among multiple holdings. As a result, investors can minimize their exposure to the risks associated with investing in a single stock and benefit from a more balanced portfolio.

Professional Management

One key advantage of high-return equity mutual funds is that experienced and knowledgeable investment professionals manage them. These fund managers conduct in-depth research, monitor market trends, and analyze companies to identify promising investment opportunities. Their expertise allows them to make informed decisions on behalf of the investors, aiming to achieve superior returns. Investors can benefit from the skills and experience of these professionals, even if they have limited knowledge or time to devote to individual stock analysis.

Liquidity

Equity mutual funds offer investors liquidity, which means they can buy or sell their shares on any business day. This flexibility allows investors to access their funds quickly and easily, providing them with the freedom to enter or exit their investment positions. Unlike other investment options, equity mutual funds offer high liquidity, making them a preferred choice for those who value accessibility and convenience.

Affordability

Equity mutual funds provide an affordable option for investors to participate in the stock market. With a relatively low initial investment requirement, individuals can gain exposure to a diversified portfolio of stocks that might otherwise be financially out of reach. Moreover, investors can benefit from economies of scale by investing in equity mutual funds, as the expenses associated with managing the fund are spread among a large pool of investors. This cost advantage enhances the overall return potential for investors.

Potential For Higher Returns

Equity mutual funds can deliver higher long-term returns than other investment instruments. Historically, equity markets have demonstrated a track record of providing attractive returns over extended periods. While past performance does not indicate future results, equity mutual funds with high returns allow investors to tap into the growth potential of well-performing companies and benefit from their success. Additionally, through compounding, investors can enjoy the advantages of reinvesting dividends and capital gains, further boosting their overall returns.

Factors to Consider when Investing in Equity Mutual Funds

It is necessary to be aware of certain factors that affect your investment. In the case of equity funds, these factors include your investment goals, the performance of your funds, your risk appetite, and others.

Risk Appetite

When choosing equity mutual funds, it is essential to consider your risk appetite. Some funds are more aggressive and have the potential for higher returns but also come with higher risks. On the other hand, more conservative funds offer steady growth but with lower risk. Assess your tolerance for risk before making a decision.

Investment Goals

Clearly defining your investment goals is crucial when investing in equity mutual funds. Are you investing for short-term gains or long-term wealth creation? Do you have specific financial targets, such as retirement savings or house purchases? Understanding your goals will help you choose the suitable funds that align with your objectives.

Fund Performance

Examining a fund’s past performance is one way to gauge its potential. Look for funds that have consistently delivered good returns over several years. However, remember that past performance is not a guarantee of future results. It is just one factor to consider among many.

Expense Ratio

The expense ratio represents the annual fees charged by the mutual fund company. Though it may seem insignificant, even small differences in expense ratios can significantly impact your overall returns over time. Compare expense ratios across funds to ensure you are getting good value for your money.

Fund Manager’s Track Record

The fund manager plays a crucial role in an equity mutual fund’s performance. Look for a fund managed by an experienced professional with a consistent track record of delivering solid returns. A skilled fund manager can navigate market fluctuations and make informed investment decisions, contributing to the fund’s success.

How to Invest in Mutual Funds?

By following these steps, you can invest in mutual funds and build a diversified portfolio that helps you achieve your financial goals:

Step 1. Identify why you want to invest and what you hope to achieve. Are you saving for retirement, a child’s education, or a major purchase? Your goals will help determine the type of mutual fund that suits your needs.

Step 2. Based on your goals and risk tolerance, select the type of mutual fund that aligns with your objectives. Equity funds for growth, bond funds for stability, hybrid funds for a mix of both, or sector-specific funds for targeted investment.

Step 3. Use resources like fund fact sheets, prospectuses, and financial websites to compare mutual funds. Look at their performance history, fees, investment strategy, and the fund manager’s track record.

Step 4. Once you’ve researched, choose the mutual fund that best fits your criteria.

Step 5. You can invest in mutual funds directly through the fund company, a brokerage account, or a financial advisor. It usually involves filling out an application form with personal and financial information.

Step 6. Deposit the money you plan to invest into your account. It can often be done via bank, check, or wire transfer.

Step 7. Decide how much money you want to invest in the chosen mutual fund. You can buy shares in lump sums or set up a systematic investment plan (SIP) to invest a fixed amount regularly.

Step 8. After investing, regularly review your mutual fund’s performance to ensure it aligns with your goals. Keep an eye on market conditions and read the fund’s periodic reports.

Step 9. Based on your review, you might need to rebalance your portfolio or switch funds if your investment objectives or market conditions change.


Step 10. If you’re unsure, consider consulting a financial advisor for personalized guidance.

Who Should Invest in Equity Funds?

Equity funds can be a good investment option for a wide range of individuals, but they are particularly well-suited for investors with the following characteristics:

Long-term Investment Horizon

Equity funds are best suited for investors with a long-term investment horizon, typically five years or more. The stock market can be volatile in the short term, but it has historically trended upwards over the long term. Investing for the long term allows investors to ride out the market’s ups and downs and potentially reap the rewards of higher returns.

Young Investors Just Starting to Save for Retirement

Young investors have a long time horizon and are likelier to weather the stock market’s ups and downs. They can also afford to take on more risk, as they have more time to recover from losses.

Investors Saving for a Long-Term Goal

Equity funds can be an excellent way to save for a long-term goal, as they have the potential to grow your money faster than other types of investments.

Investors Comfortable With Risk and Are Looking for High Returns

Equity funds can offer the potential for high returns but also have the risk of significant losses. Investors comfortable with this level of risk may be willing to accept the potential for higher returns in exchange for the added risk.

Risk-averse investors or those with a short-term investment horizon should consider other investments, such as bonds or money market funds.

Tips for Building a Strong Equity Mutual Fund Portfolio

A Strong portfolio to get more from your investments and a backup plan to bear any losses. A good portfolio will help diversify the losses and keep you safe during adverse times.

Asset Allocation

Allocate your investments across different types of equity mutual funds to diversify your portfolio. Consider investing in large, mid-, and small-cap funds to spread the risk. Additionally, diversify across different sectors to avoid concentration in one area.

Regular Monitoring and Rebalancing

Keep a close eye on your equity mutual fund portfolio and regularly review its performance. Rebalancing involves adjusting the portfolio to maintain the desired asset allocation. If certain funds have performed exceptionally well or poorly, rebalancing ensures that your portfolio stays aligned with your investment goals.

Systematic Investment Plan (SIP)

Consider investing through a systematic investment plan (SIP). A SIP allows you to invest a fixed amount regularly, regardless of market conditions. This strategy reduces the impact of market volatility and helps in rupee cost averaging.

Tax on Equity Mutual Fund

Investing in equity mutual funds can be a smart way to grow your wealth, but it’s essential to understand the tax implications. Let us see how taxes on equity mutual funds generally work:

Short-term Capital Gains (STCG)

If you sell your equity mutual fund units within one year of purchase, your profit is considered a short-term capital gain. These gains are typically taxed at a higher rate than long-term gains. The exact rate can vary by country, but it’s often at the individual’s regular income tax rate.

Long-term Capital Gains (LTCG)

If you hold your equity mutual fund units for more than one year before selling, the profit is classified as a long-term capital gain. In India, long-term capital gains above a certain threshold are taxed at 10% without the benefit of indexation.

Dividend Distribution Tax (DDT)

If the mutual fund distributes dividends, these dividends might be subject to tax. The tax treatment of dividends varies. Some countries tax dividends as ordinary income, while others may have specific dividend rates. In some jurisdictions, mutual funds pay the dividend distribution tax before distributing the dividends to investors.

Securities Transaction Tax (STT)

It is a tax levied on the transaction value of securities traded on stock exchanges, including equity mutual funds. STT is usually applicable at the time of purchase and sale of equity mutual fund units.

Indexation Benefit

Some tax regimes allow for an indexation benefit, which adjusts the purchase price of the mutual fund units for inflation, thereby reducing the taxable capital gain. This benefit is typically available for long-term capital gains on certain mutual funds but may not apply to equity mutual funds in all jurisdictions.

Conclusion

Focused equity funds are a solid investment choice for individuals looking for long-term wealth appreciation through exposure to the equity market. This may be accomplished through investing in equities. Compared to traditional savings vehicles, they can offer respectable returns after considering the consequences of inflation.

Key Takeaways

  • Equity mutual funds are a popular investment option that offers the potential for long-term capital appreciation.
  • Diversification and professional management are two key benefits of investing in equity mutual funds.
  • Equity mutual funds are also liquid and affordable, making them a good choice for many investors.
  • Equity mutual funds are subject to market volatility and systematic and unsystematic risks.

FAQs

1

Is it good to invest in equity funds?

Equity funds can be a good investment for long-term investors with a high-risk tolerance. They can offer the potential for high returns, but they also come with the risk of significant losses

2

Are equity funds high-risk?

Yes, equity funds are considered to be high-risk investments. This is because they are directly invested in stocks, which can be volatile and unpredictable. However, this risk can also be mitigated by diversifying your portfolio and investing for the long term.

3

Which is better, mutual fund or equity?

Mutual and equity funds are both investments that can grow your wealth. However, there are some key differences between the two. Mutual funds can invest in various assets, including stocks, bonds, and cash. Equity funds, on the other hand, only invest in stocks. This means that equity funds are generally more volatile than mutual funds and have the potential for higher returns.

4

Which type of equity fund is best?

The best type of equity fund for you depends on your investment goals and risk tolerance. There are various equity funds available, each with its investment strategy. Some common types of equity funds include large-cap funds, small-cap funds, growth funds, and value funds.

5

What are the subcategories of equity funds based on investment objectives?

Equity funds are categorized based on investment focus: Large-cap, Mid-cap, Small-cap, Multi-cap, Focused, Index, Thematic, and Sectoral. They also differ by risk appetite: Aggressive, Balanced, and Conservative.

6

Who should invest in equity mutual funds?

Equity funds suit investors with a long-term horizon (5+ years) and a higher risk appetite. They offer the potential for substantial returns but also involve market volatility.

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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