Equity Mutual Funds - Meaning, Types, and Benefits

How Do Equity Mutual Funds Work?

Equity mutual funds primarily invest in equity shares (stocks) of various companies. When you invest in an equity fund, you essentially become a shareholder in the companies the fund chooses to invest in.

What Determines Stock Selection?

Two main factors influence the selection of stocks in an equity mutual fund:

• Fund Category: The type of equity fund (like large-cap, mid-cap, etc.) determines the eligible stocks for investment.
• SEBI Regulations: Equity funds must follow the rules set by SEBI (Securities and Exchange Board of India) based on their category — either by investment universe or investment style.

Example: Large Cap Funds must invest at least 80% of their corpus in India’s top 100 large-cap companies. This category definition sets the boundaries of where the fund can invest.

Role of the Fund Manager

Once the fund category and investment universe are defined, the fund manager and their team step in. These professionals are experts in market and financial analysis.

They:

1. Conduct research using technical and fundamental indicators
2. Analyze company profitability, industry outlook, and economic resilience
3. Make decisions such as: Which stocks to buy At what price to buy/sell How much to invest in each stock
   1. Which stocks to buy
   2. At what price to buy/sell
   3. How much to invest in each stock

Ongoing Monitoring and Adjustments

After stocks are purchased:

1. Fund managers monitor the performance of the companies and industries
2. They keep an eye on the overall economy and market conditions
3. If a company underperforms or deviates from expectations, the stock is removed from the portfolio
4. They also invest early in companies showing high growth potential

Fund managers continuously track the financial markets and economic trends, enabling them to:

1. Make tactical investment decisions
2. Manage market volatility
3. Maximize opportunities in the equity market

Features of Equity Mutual Funds

The following are some primary features of equity mutual funds in India:

Reduced Expense Ratio: Regular purchase and sale of shares in an equity fund may result in a rise in the scheme's expense ratio. A 2.5% cap has been set by the SEBI on the expense ratio for equity funds. Additionally, the SEBI could further lower it.

Portfolio Diversification: By making a small investment, you can expose yourself to a number of high-quality equity shares through equity funds. Your equity portfolio is therefore diversified and provides a better chance to produce profitable returns.

Tax Benefits: The Equity Linked Savings Scheme (ELSS) provides tax exemption under Section 80C of the Income Tax Act in exchange for equity exposure. It offers excellent potential to obtain good returns and has a short lock-in period of three years. An ELSS can also be purchased in instalments.

Benefits of Equity Funds

The following are the benefits of investing in equity funds:

1. Experts manage your investments.
2. It is flexible and provides liquidity.
3. It is convenient, cost-effective, and provides diversification.
4. You can choose systematic investments.

Who Should Invest in Equity Funds

For the purpose of calculating taxes, a fund is considered to be equity-oriented if at least 65% of its assets are made up of equity or securities with an equity focus.

🧑‍💼 1. Investors Who Want to Invest in Stocks but Lack Knowledge or Time

Many individuals are interested in investing in the stock market. However, they are unable to do so due to a lack of time to conduct the required research and continuously analyse markets. Equity mutual funds offer a good opportunity for such investors. All that is required is choosing a solid fund and making regular investments in it. The fund manager will manage the investment.

📅 2. Investors Who Can Commit for Over Five Years

While equity funds can produce good returns over the long term, they can be uncertain in the short term. Therefore, investors with goals beyond five years, such as retirement or children’s education—can consider equity funds.

💸 3. Investors Who Wish to Invest a Small Amount

Some investors are interested in equity markets but only want to make small investments. With equity funds, you can start investing with as little as ₹100.

💼 4. Investors Seeking to Save Taxes While Growing Wealth

Equity funds can benefit those who want to grow wealth over the long term and save tax. ELSS (Equity Linked Saving Scheme) is a category of equity fund that offers tax benefits under Section 80C of the Income Tax Act. Investors can lower their taxable income by ₹1.5 lakh by investing in ELSS, while also earning good returns.

Taxation on Equity Funds

Taxes must be paid on dividends and capital gains received from equity funds.

🧾 Capital Gains

Capital gains are the difference between the cost of mutual fund units and the price at which they are sold.

💰 Dividend Taxation

Dividends are added to the investor’s income and taxed as per their income tax bracket:

1. If the investor is in the 20% tax bracket, the dividend is taxed at 20%.
2. If in the 30% tax bracket, the dividend is taxed at 30%.

🕒 Long-Term Capital Gains (LTCG)

1. If the holding period is over 12 months, LTCG above ₹1 lakh is taxed at 10%.
2. Example: LTCG = ₹1.5 lakh → Taxable = ₹50,000 → LTCG tax = ₹5,000 LTCG = ₹90,000 → No tax applicable
   1. LTCG = ₹1.5 lakh → Taxable = ₹50,000 → LTCG tax = ₹5,000
   2. LTCG = ₹90,000 → No tax applicable

If investors choose the Dividend Plan of an equity fund, dividends are declared when there's excess corpus to be distributed.

⏳ Short-Term Capital Gains (STCG)

1. If the holding period is less than 12 months, STCG is taxed at 15%.
2. Example: Short-term gain = ₹1 lakh → Tax = ₹15,000

How to Invest in Equity Funds

Before investing, consider your financial goals, risk appetite, and investment horizon. Investors generally fall into two categories:

🆕 New Entrants

First-time investors often:

1. Have limited capital
2. Lack time to monitor markets
3. May not know how to pick stocks

For them, equity mutual funds—especially large-cap funds—are ideal. These invest in top companies and offer stable, long-term returns.

🧠 Seasoned Investors

Experienced investors can:

1. Take calculated risks
2. Explore diversified equity funds
3. Use their market knowledge to earn higher returns than basic equity funds

Before making an investment decision, you should carefully consider your financial objectives, risk aversion, and investment horizon. There are two types of investors: new entrants and experienced investors.

Tips to Choose the Right Equity Mutual Fund

Whether you’re a first time investor or a seasoned one with good knowledge of the mechanics, a through research is required since it's relatively a long term investment. In India, there are thousands of active funds out of which a couple of hundred are bent towards equity. Let's explore a few points which require attention before choosing a specific fund. Remember, not all of them are high performing products. While some just offer average returns, others set benchmark for the market to follow.