What is an equity fund? types, benefits and more

There are several mutual funds in India categorised as per investing style, risk appetite, objectives, etc. The Securities and Exchange Board of India (SEBI) classifies mutual funds into five broad types. These include equity schemes, debt schemes, hybrid schemes, solution-oriented schemes for retirement and children, and other schemes like index funds, Exchange Traded Funds (ETFs), and fund of funds. In this guide, you can learn more about the first category what is an equity fund, its types, benefits, and other essential details.

What is an equity mutual fund?

Wouldn't life be much easier if you could invest in different stocks without spending a lot of time or without even having sufficient market knowledge? Say, thanks to equity mutual funds. These schemes invest in stocks of other companies. And the best part is that these companies are spread across sectors, themes, market capitalisations, etc. Equity mutual funds, thus, offer enough diversification and aim to help you with capital appreciation and wealth creation. Yes, the risk level associated with these funds is relatively high, but so is the potential of returns compared to others.

Types of equity mutual funds

To help you make better investment decisions, SEBI distinguished equity funds into different categories according to market capitalisation and other criteria. Market capitalisation refers to the market value of a company's outstanding shares. Based on market capitalisation, you will find three types of companies large-cap, mid-cap and small-cap. Large-cap companies are ranked as the top 100 companies listed in the stock market by SEBI. Mid-cap companies are second in line and are ranked between 101 and 250. Small-cap companies are ranked from 251 onwards. Although equities are high-risk investments, the risk involved varies. For example, out of the three, large-cap stocks are considered to have the lowest risk and small-cap stocks are considered to be the riskiest.

Here are the different equity mutual funds as per market capitalisation:

• Small-cap funds: Small cap funds invest at least 65% of their assets in small-cap stocks 
• Large-cap mutual funds: These funds invest at least 80% of their assets in large-cap stocks. 
• Mid-cap funds: At least 65% of the assets of these mid cap funds
• Multi cap funds: With investments across market capitalisations, these schemes invest a minimum of 65% of their assets in equity and equity-related securities. 
• Large and mid-cap funds: These funds invest at least 35% of their assets in large and mid-cap stocks each. 

SEBI also categories equity mutual funds as the following:

• ELSS: Equity-Linked Savings Schemes (ELSS) invest at least 80% in stocks. These are the only mutual funds that qualify for a tax deduction under Section 80C of the Income Tax Act, 1961. 
• Dividend yield funds: These schemes invest at least 65% of the total assets in dividend-yielding stocks. 
• Value funds: With a minimum investment of 65% in equity and equity-related securities, these funds invest in undervalued stocks that have the potential to grow. 
• Contra funds: With a minimum investment of 65% in equity and equity-related securities, these funds invest in underperforming stocks with a belief that they will perform in the long run.
• Focused funds: With at least 65% of the assets in equity and equity-related securities, these funds invest in a maximum of 30 stocks. 
• Sectoral and thematic funds: These funds invest a minimum of 80% in stocks of a particular sector or theme respectively. 

How do equity funds work?

As with any other mutual fund, equity funds also pool money from different investors and majorly invest it in the stock market. Equity funds primarily focus on equity or equity-related securities with a minimum of 65% allocation in stocks. The remaining is invested in debt securities or money market instruments. You can invest in equity funds through a Systematic Investment Plan (SIP) or a lump sum. The former allows you to invest regularly in small but steady instalments made weekly, monthly, yearly, etc., in a mutual fund scheme of your choice. You can use an SIP return calculator to plan this better. On the other hand, lump-sum investments can be made at once as and when you have surplus funds. 

Benefits of equity funds

• Inflation-adjusted returns: Equity funds can deliver inflation-adjusted returns when invested for the long term. The main motive of these funds is to generate high returns for capital appreciation.
• Diversification: Equity funds invest across market capitalisations, sectors, and themes, etc. So, you can diversify your portfolio optimally by investing in them.
• Tax benefits: ELSS lets you claim a tax deduction of up to Rs. 1.5 lakh per year under Section 80C. You can, thus, save up to Rs. 46,800 in taxes annually by investing in these equity schemes. 
• Professionally managed: Equity mutual funds are managed by professional fund managers who take timely decisions to maximise your gains from the stock market. 
• Low investment amount: You can invest as little as Rs. 500 in an equity fund through SIPs. This makes it suitable for all income groups.
• Liquidity: Except for ELSS, you can redeem your open-ended equity funds at any time.

Taxation of equity funds

Gains on equity funds held for a year or less attract a short-term capital gains tax of 15%. Gains on equity funds held for more than a year attract a 10% long-term capital gains tax. However, long-term capital gains up to Rs 1 lakh/year are tax-free.

Should you invest in equity mutual funds?

The next question, after what is an equity fund, is usually whether or not you should invest in it. Equity funds are suitable for long-term goals and can deliver inflation-adjusted returns over a long investment horizon. However, they carry high risks. You can consider investing in them if you have a high tolerance for risk and a long-term investment perspective. Tax savings is another reason to invest in these funds. So, if that is your concern, you can invest in ELSS.

Conclusion 

Equity funds can help with capital appreciation in the long term. However, it is crucial to choose a   suitable scheme based on your goals. Since they have relatively high risk, it may also be advised to research a bit and then select a mutual fund scheme that fits your criteria.

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