Equity Mutual Funds: Definition, Types, Benefits, Returns & Taxation Policy

Also known as growth funds, equity mutual funds are preferred by investors who have a high-risk tolerance. Despite the high risk it holds, this investment asset has the potential to generate high returns in the long-run. Fund managers of equity mutual funds aim to maximise the profits by selecting stocks of different companies based on the investment objective of the fund.

With equity funds, there is no ‘not one size fits all’ principle. There are different types of equity mutual funds that you may choose to invest in as per your financial goals and risk tolerance. 

Read on to know the different types of equity mutual funds, their benefits and the type of returns that you generate. 

What are Equity Mutual Funds?

Equity mutual funds invest in shares of various publicly listed companies in particular proportions. The Return on Investment(ROI) of equity mutual funds primarily depends on the expertise of the fund manager and the performance of the companies listed in the fund portfolio. 

Although equity fund investments tend to be risky, it has the potential of generating higher returns than the other two types of mutual funds – debt and hybrid. 

As per SEBI regulations , every equity fund should invest a minimum of 65% of its corpus in equity and equity-related instruments. 

What Are the Types of Equity Mutual Funds? 

There are various subcategories of equity mutual funds that you can invest in. Some of the most popular types of equity funds have been listed below: 

1. Based on Market Cap

• Large-cap fund

Large-cap funds invest at least 80% of their investible corpus in equities of the top 100 companies as per market capitalisation. These companies have a proven track record of performing well in the medium to long-term horizon. This is an ideal investment option for you if you wish to generate stable returns. 

• Mid-cap fund

Mid-cap funds invest at least 65% of their assets in the companies ranking 101^st – 250^th in terms of market capitalisation. These companies are still considered to be developing and have great growth potential. While mid-cap funds are riskier than large-cap funds, they  also hold possibilities of higher returns. 

• Small-cap fund

Small-cap funds invest a minimum of 65% of their assets in small-cap companies, which are listed 251^st and above in terms of market capitalization. These funds have the potential to generate higher returns than large and mid-cap funds but also tend to be more volatile. 

• Multi-cap fund

Multi-cap funds invest in stocks across market capitalisation and their portfolio comprises of large cap, midcap and small cap stocks. This is an ideal investment choice for people who want a diversified and low-risk portfolio.  

2. Thematic Equity fund

Thematic funds are mutual funds which invest at least 80% of their assets in theme-based stocks. These stocks are of companies belonging to a particular theme of sectors such as Consumption, Infrastructure, Technology, etc. As a result, these portfolios tend to be risky because the investible corpus is directed to a particular group of companies. 

3. Contra Equity Fund

Contra funds take a contrary view to investing and invest at least 65% of their assets in equities and equity-related instruments against the tide, i.e., they invest in the stocks of those companies that are currently not performing well; however, there are high chances of a turnaround in the long-term. However, this is a risky move being taken by the fund manager. Hence, while providing high returns, these portfolios tend to be a riskier fund.

4. Tax Saving fund

Tax-saving funds, as the name suggests, offer tax benefits to investors. The ELSS (Equity Linked Savings Scheme) fund is one of the best known tax-saving investment options. It invests at least 65% of its assets in equity and equity-related instruments. 

ELSS comes with a three-year lock-in period and offers a deduction of up to ₹1.5 lakh on your investment u/s 80C of the Income Tax Act. 

5. Focused Equity Fund

Focused funds invest at least 65% of their investible corpus in equity and equity-related instruments. They focus on a small concentration of companies to invest in. They can invest in a maximum of 30 stocks across all market capitalisations, thus offering a well-diversified portfolio to the investors. 

6. Sector Equity Fund

Fund managers of sector equity funds invest a minimum of 80% of their assets in stocks of companies belonging to a particular sector, such as banking, pharmacy and FMCG. Your investments will have limited exposure, but there is potential to generate great returns if that sector is growing. 

What Are the Benefits of Investing in Equity Mutual Funds? 

Here are some of the most prominent benefits of investing in equity mutual funds:

• Diversification

With equity funds, you can create a diversified portfolio which is exposed to different sectors of the economy and allows investment across market capitalization. This is less risky than investing directly in stocks as the underperformance of some stocks can be offset by the outperformance of other stocks.

• ROI potential

Among all types of mutual funds, equity funds hold the potential to generate the highest returns. This is one of the reasons why it is a popular choice among investors who have a high-risk tolerance. 

• Affordability

You can start investing in equity funds through a Systematic Investment Plan (SIP) or the lump sum payment method. Most equity mutual funds let you start with a minimum SIP deposit of ₹500. 

• Tax benefit

Tax-saving equity funds like ELSS offer a deduction of up to ₹1.5 lakh on your investment under Section 80C of the Income Tax Act. As a result, it significantly lowers an individual’s overall taxable income. 

• Liquidity

Unlike other investment options such as fixed term deposits and bank deposits, you can liquidate your equity investment on short notice.  

Return on Investment for Equity Mutual Funds

Despite being a risky investment vehicle, equity mutual funds have a high return potential. As a result, these funds are becoming a preferred investment choice for individuals who wish to beat inflation and build wealth over time. 

Following is the list of top 5 equity mutual funds to invest in 2022. This will offer you an idea of the returns that equity funds generate. 

Taxation  on Equity Mutual Fund

Any mutual fund with investments of at least 65% in equity or equity-related instruments is considered an equity fund and is taxed as the same under the Income Tax Act. If the units are held for less than a year, the returns generated from equity funds are regarded as short-term capital gains (STCG); if the units are held for more than a year, the returns become long-term capital gains (LTCG).  

Here are the tax implications of investing in equity mutual funds: 

• Short-term capital gains are taxable at a rate of 15%, cess and surcharge applicable. 
• Long-term capital gains exceeding ₹1 lakh are taxable at 10%, and no indexation benefit is applicable. 
• STCG losses can be carried over and set off against both long-term and short-term capital gains. However, LTCG losses can only be set off against long-term capital gains. You can carry forward such losses for a maximum of 8 years if not adjusted in the current year. 
• Dividends earned on equity and debt funds are now considered taxable under the head of ‘other income’ and are taxed as per his/her income tax slab.. 

Tips to Consider while Investing in Equity Mutual Funds

You should review how your fund performs periodically and do the needful if it is underperforming. When a fund’s unit price or NAV (Net Asset Value) falls much below expectations, it is considered to be underperforming. 

Here are some points that you should consider before investing in equity funds:

• Asset allocation

Before investing in a mutual fund scheme, make sure to study the fund manager’s portfolio. Try to assess whether the investible corpus will be allocated to companies that you are comfortable investing in. 

If you are hopeful regarding a particular sector, you can go for sectoral/thematic mutual funds. There are other options if you wish for stable returns such as investing in large cap equity mutual funds. 

• Review your fund 

Review your fund periodically to see if it is underperforming or outperforming. Fluctuations are inevitable in the stock market, but if a fund is consistently underperforming, consider reassessing your investment plans. 

Final Word 

Equity mutual funds are suitable investment options for investors who have a long-term investment horizon and high-risk appetite. Although the fund manager plays a crucial role when it comes to generating returns, you should also review these funds periodically to make sure it aligns with your financial goals. 

Frequently Asked Questions 

Q. Who should consider investing in an equity mutual fund? 

Ans. Investors with moderate to high risk appetites and long-term investment goals should consider investing in equity funds. It is important to assess a fund’s portfolio and the expertise of the fund manager before going ahead with any investments. 

Q. Can I invest through SIP in equity funds? 

Ans. Yes, you can invest in equity funds through SIP or Systematic Investment Plan to enjoy the benefits of compounding. In addition, investing through SIP creates a healthy habit of systematic savings, which is beneficial for every individual. 

Q. What is the Compound Annual Growth Rate (CAGR)?

Ans. Compound annual growth rate is the average annual growth rate of a fund over a specified period of time. It denotes the rate of return that is generated from a mutual fund.