How to invest in Equity mutual funds?
Investment requires a sensible and cautious approach to avoid potential loss of capital. Hence, it is important to understand the basics of different types of schemes available and analyze each of them to choose the right scheme to invest your money. All of these solely depend on your financial goals and risk tolerance. With the course of time, mutual funds have evolved into a preferred investment option for many investors.
However, choosing the right fund to invest in might be baffling for investors due to the wide range of schemes available. Equity mutual funds are those funds that basically invest in stocks or shares of various companies or businesses that tend to grow over time thus generating profits for its shareholders. These are the riskiest class of mutual funds and hence they are likely to produce higher returns than other mutual funds. There are various types of equity mutual funds that are categorized according to the risk levels, investment style and kind of stocks they invest in.
Types Of Equity Funds:
- Based On Sectors:
Equity funds that invest in some particular sector like FMCG, pharma or technology or themes like infrastructure, energy, rural India etc fall under this category. These funds are of high risk as the investment made is based on the perception of the fund managers. Their performance depends on both the sectoral and market risks.
- Based On Market Capitalisation:
Equity funds that invest in specific market capitalisation only, come under this category. They are large cap, mid cap or small cap funds. Large cap funds are those that invest 80% of their total assets in shares of large cap companies. These are more stable than mid cap and small cap funds. Mid cap funds are those that invest 65% of their assets in shares of mid cap companies. They offer better returns than large cap funds but are not as stable as them. Small cap funds invest in shares of small cap companies. They are prone to market inconsistency and risk.
- Based on Investment Style:
Active funds and passive funds fall under this category. Active funds are actively managed by fund managers who choose the shares to invest in. But passive funds are those that follow a particular market index such as sensex, that decides the list of shares that the scheme will invest in. Here, the fund managers have no active role.
- BASED ON TAX BENEFITS:
Equity Linked Saving schemes (ELSS) Funds is the only scheme that offers tax benefits of up to Rs 1.5lakhs. These schemes invest their assets in equity related options and have an investment tenure of 3 years. Except ELSS all other equity funds are subject to capital gains tax and Dividend Distribution Tax(DDT) which is deducted at source.
Keeping in mind that the regular buying and selling of shares can lead to an increase in the expense ratio, the Securities and Exchanges Board of India(SEBI) has assigned an upper limit for the expenses ratio of equity funds at 2.5%. This will allow more returns for investors. Equity funds give you an exposure to invest in various good equity shares and this helps in widening your investment portfolio and offers you a better opportunity to earn good returns. Through equity funds you can invest in the capital market without worrying about choosing individual stocks or shares to invest directly as your investment is managed by experienced professionals which is cost effective and convenient. It offers liquidity and flexibility too. Except ELSS, all the mutual fund units are liquid and can be sold whenever you need to encash your investments.
Apart from all these, you have to choose between a lump sum or Systematic Investment Plan(SIP). If you want to invest a lump sum amount, you need to invest at the right time to earn good returns. If you invest in a wrong time, then you might encounter losses. Systematic Investment plan reduces this risk by allowing you to invest the same amount spread over a large period. SIP also gives you the benefit of Rupee Cost Averaging(RCA) where the average cost of buying a single unit reduces over time and this saves you from the market volatility and risks. While investing in equity funds, keep in mind that the investments are for long term financial goals. The golden rule for investing in equity funds is to diversify so that you can reduce risks and get maximum capital gains and tax benefits. Also, track the performance of the fund house and evaluate the long term returns that it has generated.
Generally equity funds are known to deliver around 10-12% returns on an average (pre-tax). They are less risky than stocks and come with a number of benefits. To generate maximum returns it is highly important to understand the working and objectives of equity funds and hence, analysing it with your risk profile. Also, it’s recommended to know the expense ratio of the fund and it could impact on your returns.