Equity Mutual funds invest primarily in equity shares of listed companies across sectors and market capitalization segments. Equity mutual funds in India are one of the best long term investment products and ideal for meeting your long term financial goals like, retirement, higher education and marriage of your children or simply for creating wealth.
But before we explore what are the various types of equity mutual funds, let us first see the benefits of investing in equity mutual funds in India.
Equity is the best performing asset class in the long term: Historical data shows that, equity is the best performing asset class if your investment period had been long. In the last 20 years, the BSE Sensex has given 10.8%, while gold has given 8.6% and bank FDs have given 7.8% annualized returns respectively (Source: BSE India, World Gold Council and SBI FD Rates).
Had you invested Rs 1 Lakh in the BSE Sensex 20 year back it would have grown to Rs 7.80 lakhs, while the same amount invested in gold and FDs would have grown to only Rs 5.20 lakhs and Rs 4.49 lakhs respectively!
Likewise, had you invested Rs 1 Lakh in top 5 diversified equity mutual funds 20 years back, you could have accumulated anything between Rs 36 Lakhs to 83 Lakhs. Top diversified equity mutual funds gave over 19 – 24% annual returns during the last 20 years period.
Diversification of risk: By investing in a diversified equity mutual fund portfolio which has invested in stocks of different sectors and size of the companies, you are able to diversify company and sector specific risks up to a greater extent. Mutual funds work on the concept of pooling of money from many investors; therefore, you can diversify your risk even with a small investment amount of Rs 5,000 or even Rs 500 in case you are investing in ELSS Funds.
Mutual funds are managed by professional: Mutual funds, irrespective of whether it is an equity funds or debt fund are helmed by qualified fund manager(s) who is supported by a team of research analysts who have the necessary experience and expertise to analyse the complex factors involved in stock picking. Also, the fund manager’s track record is available in the public domain (generally on mutual fund research website and the AMC website), therefore, leveraging their expertise and experience you can expect superior returns on your equity mutual fund investments.
You can create a big corpus by starting small: Yes, you can invest as small as Rs 1,000 as lump sum in equity funds or start investing a small amount of Rs 500 through monthly systematic investment plans (SIP). SIPs offer a convenient mechanism of investing small amounts at a specified interval, every month or fortnight or quarter on a fixed date. You can accumulate a large corpus through SIPs in equity funds.
For example – You can accumulate a corpus of around Rs 50 Lakhs over 20 years by investing only Rs 5,000 through monthly SIPs, assuming annual return of 12%.
Equity mutual funds help you reach your future goals: As we discussed, equities are the best asset class in the long run, therefore, if you target to reach your future goals, equity mutual funds are the best bet. Knowing your future goals and then saving regularly through monthly SIPs can be the simplest way to reach your long term financial goals.
For example – You have 3 future goals. Rs 50 Lakhs for your child’s higher education after 15 years, 75 Lakhs for your child’s marriage after 22 years and 4 Crores for your retirement after 35 years. You can save monthly Rs 10,000 for 15 years to meet the first goal, Rs 6,000 per month for 22 years to meet the second goal and Rs 7,000 monthly for 35 years to meet your retirement goal of Rs 4 Crores.
As you can see, how easy it is to reach your long term financial goals if you can save in equity mutual funds in a disciplined way over a long period of time.
(Returns assumed at 12%. Source: https://www.advisorkhoj.com/tools-and-calculators/target-amount-sip-calculator)
Tax Advantage: Equity mutual funds enjoy significant tax advantages as long term capital gains are totally tax free (investments held for more than 12 months). Short term capital gains are taxed at 15% only (investments held for less than 12 months). Dividends paid by equity mutual funds are also tax free.
What are the various types of equity funds?
There are various types of equity funds suiting the different risk profile of respective investors. Investors must choose equity mutual funds based on their risk taking appetite and investment horizon. We suggest that one must have a minimum 5 year investment horizon to invest in equity mutual funds.
Diversified equity funds
Diversified equity mutual funds invest across various sectors and market capitalizations which ensure that the negative performance of one sector does not affect the entire portfolio and increases the possibility of making a sustainable return in the long run. Diversified equity mutual funds aim for medium to long term capital appreciation and are suitable for investors with high risk profile and investment horizon- of at least 5 years.
Large cap equity funds
As the name suggests, large cap equity funds invest in large cap companies which have a market capitalization of over Rs 20,000 Crores. These companies are large and well established names with strong market share. Large cap companies are generally considered safer investments compared to mid and small cap companies. Large cap funds are suitable for Investors with moderately high risk profile and investment horizon of at least 5 years. Some of the well-known large companies are HDFC Bank, Tata Motors, Infosys, Reliance Industries, State Bank of India, ICICI Bank and Maruti Suzuki etc.
Mid and small cap equity funds
Mid and small cap equity mutual funds invest primarily in mid and small companies of different sectors which typically have market capitalization ranging from Rs 5,000 Crores to upto Rs 20,000 Crores. These companies are less well known and therefore perceived to be riskier. But if the right mid and small company stocks are identified by the fund manager then they can be multi-baggers too.Mid and small cap equity funds are suitable for Investors with high risk profile having investment horizon of 5 years or more.
Would you like to know what should be the percentage of mid-caps in your mutual fund portfolio?
Equity-linked Saving Schemes
Equity-linked Saving Schemes or ELSS Funds are essentially diversified equity funds but they have lock-in period of 3 years from the date of investment as one can save taxes under Section 80C of The Income Tax Act 1961 by investing maximum Rs 150,000 in a year. ELSS funds are suitable for Investors who have minimum 3 years investment horizon after which they can redeem their investments, if they so wish.
Among all the tax savings options ELSS has the least lock-in period and have created maximum wealth for the investors compared to traditional tax saving options. In the last 10 years good performing ELSS funds have given annualized return between 11-14% which is quite higher compared to PPF, NSC and tax savings fixed deposits (source: Avisorkhoj)
You must read – Did you know ELSS mutual funds are better option than PPF
Sectoral equity funds invest in companies of a single or related sector. Returns depend on the growth of the sector and if the sector does perform well, the returns can be more than that of large cap or diversified equity funds. Sectoral funds carry the highest risk and thus suitable only for investors with very high risk taking ability and long term investment horizon of beyond 5 years. Investment experts suggest that you should not have more than 15-20% of your total portfolio exposure to sector funds.
If you are interested in reading about sector funds, you may like to know if you should invest in banking sector mutual funds
Index fund invests in the basket of securities that replicates the composition of a market index, like Nifty, Sensex, Bank Nifty, CNX – 100, CNX – Midcap, Nifty - CPSE etc. Unlike diversified equity funds, fund manager of an index fund do not aim to beat the benchmark index but tries to replicate returns of the index it is following. The primary objective of an index fund is to reduce the tracking error with respect to the index. Since index funds are passively managed, the expense ratios of index funds are lower than actively managed funds.
As we can see equity funds are the best investment class not only because they offer superior returns over traditional investments, fixed deposits or Gold, but they are also tax efficient. Long term capital gains and dividends are tax free. Not only that using equity funds as an asset and investing through SIPs can help you achieve your long term financial goals. Equity funds help you save taxes too if you invest in ELSS Funds. Investors must assess their risk profile and the investment horizon before investing in the right equity mutual fund.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.