Equity mutual funds predominantly invest in equity shares (stocks) of various companies. By investing in an equity fund, an investor becomes a part-owner of the companies the fund has invested in, enjoying both the potential profits and the risks associated with these companies.
UNDERSTANDING EQUITY FUNDS
Categories and Investment Styles
The stocks that an equity fund will invest in depend on two main factors: the category of the fund and the investment style mandated by the Securities and Exchange Board of India (SEBI).
- Large Cap Funds: These funds invest at least 80% of their corpus in the top 100 companies in India by market capitalization. Large-cap companies are typically more stable and less volatile compared to smaller companies.
- Mid-Cap Funds: These funds must invest at least 65% of their total assets in mid-sized companies. Mid-cap companies often have higher growth potential compared to large-cap companies but come with increased volatility.
Role of the Fund Manager
Once the category and investment universe of an equity fund are defined, the next step involves stock selection. Fund managers and their teams, who are experts in markets and finance, play a crucial role in this process. They analyze various technical and fundamental indicators such as profitability, economic resilience, and sector performance to make informed investment decisions. They also continuously track the performance of the invested companies and sectors, making adjustments as needed to optimize the fund’s performance.
HOW DO EQUITY FUNDS EARN?
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Capital Gains
Equity funds earn by buying shares of a company at a lower price and selling them at a higher price. The fund manager monitors the market to decide when to exit a stock to maximize profits. The gains from these sales are known as capital gains. These gains are then reinvested, benefiting from the power of compounding, where returns are earned on previous returns.
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Dividends
Another source of returns for equity funds is the dividends distributed by the companies in which they invest. Since the mutual fund owns a part of the business, it receives a share of the profits in the form of dividends. The fund manager decides how to reinvest these dividends to further grow the fund’s value.
WHO SHOULD INVEST?
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Investors Seeking Equity Exposure without Expertise
Equity mutual funds are ideal for individuals who want to invest in equities but lack the expertise or time to research and track the market. By selecting the best mutual funds in the equity category and investing regularly, these investors can rely on the fund manager to handle the complexities of the market.
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Investors with Small Investment Amounts
Equity funds are accessible to investors with small amounts to invest. One can start with as little as ₹100, making it easier for more people to participate in the equity market.
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Long-Term Investors
Equity funds can be volatile in the short term but have the potential to generate substantial returns over the long term. Investors with goals more than five years away, such as retirement or children’s education, can benefit from investing in equity funds. Even without specific goals, long-term investors seeking higher returns can find equity funds attractive.
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Tax-Saving Investors
Equity Linked Savings Schemes (ELSS) are a type of equity fund that offers tax benefits under Section 80C of the Income Tax Act. Investors can reduce their taxable income by up to ₹1.5 lakh while also earning good returns on their investments.
TAXATION OF EQUITY FUNDS
Dividends and capital gains earned from equity funds are subject to taxation.
Dividend Plan
In a dividend plan, dividends are distributed to investors when there is a surplus corpus. These dividends are added to the investor’s income and taxed according to their income tax slab.
Capital Gains
- Short-Term Capital Gains (STCG): If the holding period is less than 12 months, STCG is taxed at 15%.
- Long-Term Capital Gains (LTCG): If the holding period is more than 12 months, LTCG exceeding ₹1 lakh is taxed at 10%.
For example, if an investor earns a short-term capital gain of ₹1 lakh, they will pay ₹15,000 as STCG tax. For a long-term capital gain of ₹1.5 lakh, the taxable amount is ₹50,000 (after excluding ₹1 lakh), resulting in an LTCG tax of ₹5,000.
CONCLUSION
Equity mutual funds offer a way to participate in the stock market with professional management and diversified exposure. They are suitable for various types of investors, from those with limited time and expertise to those looking for tax-saving options. Understanding how these funds work and their potential returns can help investors make informed decisions and achieve their financial goals.