If you want to grow your money in the long run, you must have come across mutual funds. In mutual funds, one of the most sought-after options is equity funds. But what are equity funds, and how exactly do they work? Well, here is a full guide in simplified language that breaks down this concept for any person to understand, enabling him or her to make effective and smart investment decisions.
What is an Equity Fund? – The Simple Explanation
Just think about a huge basket. Essentially, an equity fund is a large basket holding shares of various companies.
When a company wants to raise money in order to grow, it sells small pieces of ownership called shares or stocks. When you buy a share, you become a part-owner of that company, an “equity” holder.
It does not just buy shares of one company; instead, an equity fund pools money from many investors, like you and your neighbours, into a big combined sum to buy shares in dozens or hundreds of companies. This is a form of mutual fund investment in India, wherein people collectively invest in the stock market.
A fund is professionally managed, meaning that there is a group of expert fund managers who know how to make the best decisions on where to place the fund’s money to try to maximize profits for the investors.
In other words, an equity fund is a mutual fund that primarily invests in stocks.
How Do Equity Funds Make Money?
The equity funds make money primarily through two means:
- Capital Appreciation: If the price of the stocks the fund owns goes up, so does the value of your fund units. When it sells stock for more than it paid for it, the fund makes a profit.
- Dividends: Some companies will distribute a portion of their profits to the shareholders. This is called a dividend. This dividend is collected by the fund and passed on to you, the investor.
Key Types of Equity Funds
It is common to classify equity funds according to the size of companies in which they invest and their investment objective.
Based on Company Size (Market Capitalization)
Companies are classified based on their market capitalization, which is the total value of all outstanding shares:
- Large-Cap Funds: Invest in very big, well-established companies. Generally considered less risky because these companies are stable.
- Mid-Cap Funds: Invest in companies falling in the category of being smaller than large-cap but bigger than small-cap. They offer higher growth potential with a moderate level of risk.
- Small-Cap Funds: Invest in the smallest companies.Small-cap funds carry higher volatility and may experience sharper ups and downs; they are suitable only for investors with high risk tolerance.)
- Multi-Cap/Flexi-Cap Funds: These funds invest across all three categories. This allows the fund manager to shift money depending on where they see the best opportunity.
Based on Investment Goal: Thematic/Sectoral
- Sectoral Funds: These funds invest only in companies belonging to a single industry or sector, such as only in technology. They are highly risky because all your investment depends on one sector’s performance.
- Equity Linked Savings Schemes: These funds are a variant of equity funds and enjoy a tax benefit under Sec 80C with a mandatory lock-in period of three years.
The Big Benefits of Investing in Equity Funds
Equity funds are a popular choice, and for good reasons:
- High Returns: Over a long-term period, usually over a period of 10 or more years, Equity funds have the potential to generate higher long-term returns, but they also involve market volatility and risk.
- Professional Management: You won’t have to research any stocks. Fund managers make investment decisions on behalf of investors, in line with the fund’s stated investment objective.
- Diversification (spreading risk): Because the fund holds shares in many different companies, if one company performs badly, the impact on your overall investment is usually small. You are spreading your risk widely.
- Affordability: You can start investing with a small amount, often as low as ₹500, through a Systematic Investment Plan or SIP.
- Liquidity (Easy Access): Most non-ELSS equity funds allow redemption, subject to exit loads and applicable terms
How to Start Investing? (Finding a Good Guide)
The next logical step in investment, if you are convinced that equity funds fit your financial goals, is to invest.
Most people, however, prefer to work with a well-informed guide known as AMFI-registered mutual fund distributor. These distributors help you to:
- Assess your risk profile: How much risk are you comfortable taking?
- Suggest the right funds: They recommend particular equity funds, considering your goals and risk profile.
- Handle the process: They make the investment smooth and easy.
AnAMFI-registered mutual fund distributor can help you understand available schemes and processes.)
Frequently Asked Questions (FAQs)
1. Is an Equity Fund the same as a Stock?
No, a stock is a single share of one company, while an equity fund is basically a basket holding many stocks of many different companies. Investing in a fund is far less risky than buying a single stock because the risk is diversified.
2. What is a SIP?
A SIP is a way you invest in mutual funds with a fixed, small amount, like ₹2,000, regularly, usually monthly. SIP allows periodic investment in mutual funds like recurring contributions, but unlike RD, it is market-linked and subject to fluctuations).It helps manage risk and ensures that you keep investing regularly.
3. What is the minimum time that I should stay invested in an Equity Fund?
Financial experts always advise investors to stay invested in equity funds for at least 5 to 7 years. This long-term period helps the investor overcome the short-term ups and downs of the stock market and aids in giving better returns with the power of compounding.
4. What does the term NAV mean?
NAV is an abbreviation for Net Asset Value. In other words, it is the mutual fund’s price per unit. It is calculated daily. It denotes the value of all the assets that are contained in the fund, like stocks and cash, minus its debts, all then divided by the total units held by investors.
5. Do investments in equity funds offer any tax benefit?
Yes, but only in the case of ELSS. Investments made in ELSS are allowed as a deduction under Section 80C of the Income Tax Act, but have a three-year lock-in period.