Equity Funds

What Are Equity Funds?

An equity fund is a type of investment wherein funds are that primarily invested in stocks/shares of a company. The returns from these funds depend significantly on the company’s performance and are therefore favored mainly by those with a penchant for risk. Despite this, young and budding investors are increasingly investing in equity funds, given the potential to earn the highest returns among all other investment avenues.

SIPs versus Lump Sum Investment

You can choose to invest in equity funds through a Systematic Investment Plan (or SIP) or as a lump sum amount. SIPs require you to invest a fixed sum periodically, making it affordable for the younger working class to invest in the equity market and earn high returns. It also offers the benefit of rupee cost averaging that allows investments at different levels of the market for the same price. With SIP, investors are basically mitigating the risk of market fluctuations. 

How Do Equity Funds Work?

Equity funds pool capital from small investors and invest a majority of it in stocks of companies based on the investment objective and the risk profile. In equity investments, at least 60% of the asset allocation is made purely in the stocks of companies with varying market capitalization. The remaining amount is invested into debt securities or other market-linked instruments. The profits and the losses incurred on your fund are reflected in the fund’s net asset value (NAV), which you can regularly monitor. 

A fund manager is generally involved in asset allocation and is responsible for evaluating the market conditions and investing accordingly. The fund manager balances the risk by taking advantage of the capital momentum in the market to reap maximum returns. 

Types of Equity Funds

Equity funds can be classified based on the following aspects:

Market Capitalization: The investment objective in the case of equity funds is mostly capital appreciation. This refers to the increase in the value of your investment, which subsequently earns you high returns. 

Now, the risk that you undertake to fulfill this objective depends on the market capitalization of the company that you choose to invest in. The larger the market cap of the company, the lower are the risks associated with investing in its equities. The choice of equity funds are:

Investment Strategy: There are broadly 4 strategies, viz. top-down strategy, bottom-up strategy, growth strategy, and value strategy, that investors adopt to choose the companies they want to invest in. Based on the chosen strategy, equity funds can be categorized as: 

Tax Savings: All equity funds except Equity-Linked Savings Scheme (ELSS) are subject to taxation per the capital gains earned in a year. As per the Union Budget 2022-23, short-term capital gains (STCG) from equity funds are taxable at 15%, and long-term capital gains (LTCG) at 10%.  

Equity-Linked Savings Scheme (ELSS) is a tax-saving investment vehicle that allocates nearly 80% of the assets in equities and equity-related schemes. Investors can claim tax benefits under section 80C of the Income Tax Act, 1961. 

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How To Choose An Equity Fund?

Given the large number of equity funds available in the market today, choosing one can be a struggle especially if you are new to this. It is recommended that you evaluate your financial goals, risk appetite, and investment horizon. Note that equity funds generate good returns only in the longer term, taking time to combat market fluctuations and volatility. Therefore, you should be ready to commit to a fund for at least 5-10 years. Here’s how you should go about investing in equity funds for consistent returns.

1. Investment Expertise

   If you just started on your investment journey, you should start by investing in large-cap equity funds which guarantee stable returns over the years. Since funds are invested in well-established and top-performing companies, the risk of investment is lower. Once you are more versed with the concept, you can choose to diversify your investment portfolio. 

2. Risk Appetite

   A lot of people are jumping into high-risk investments anticipating huge profits without research. As such, people end up losing a lot of their money. Make sure to balance out your risks with a diversified investment portfolio. This will help you earn consistent capital returns from large-cap funds while also offsetting the risk of losing money from volatile funds.

3. Fund Performance

   Before investing, choose the funds you wish to invest in after looking through their NAV. It is an important indicator of how well a fund is performing in the market. Investors must monitor their funds’ performance and make systematic adjustments in their portfolio to avoid incurring major losses. Check the track record of the fund house, ideally with significant assets under management (AUM). 

4. Expense Ratio

   It is the fee charged by the Asset Management Company (AMC) to manage your funds. The fund with a lower expense ratio ensures higher returns for investors. The Securities and Exchange Board of India (SEBI) has capped the expense ratio for equity funds at 2.5%. 

5. Age of the investor

   If you are a young investor with a long-term financial goal, you can benefit from the power of compounding. Power of compounding means that the profits earned are added into the initial investment sum and then the entire sum is reinvested to accelerate wealth accumulation. This only shows high returns in the longer term, which is why it is advisable to invest when you are young. If you are nearing retirement, you can choose an aggressive hybrid investment comprising of equity and debt funds to generate high returns in a short period of time. 

Is Equity Fund A Good Investment?

Equity funds are considered a good investment instrument, given the returns and the balanced risk profile. These are especially ideal for investors without a financial background or for those who want to invest systematically in fixed amounts. Another popular attribute of equity funds is the potential to diversify funds to lower risks. Diversification of funds ensures that the negative movement of an individual stock does not affect the overall investment portfolio. 

Benefits Of Investing In Equity Funds

• Funds are professionally managed by financial experts who carefully invest in stocks that have the potential to generate optimal returns for investors. 

• Systematic investment in equity funds ensures that you do not have to shell out a huge sum to enjoy the benefits of high-risk, high-return investments.

• The capital growth is significant to plan retirement and other long-term financial goals of investors. The power of compounding factors in to generate accelerated returns.

• Investors are given the option to switch between funds should they see their funds underperforming. 

Summing Up!

Equity funds in India have been performing in tandem with the market changes. Average returns from equity funds in India stand at around 10-12%. Note that this figure varies according to market conditions. It is important that you choose a fund that has shown consistent performance over the years. This will ensure healthy returns on your investments.