What Are Equity Mutual Funds: Meaning, Benefits, Types, FAQs

April 12, 2023 Mutual Fund

Equity Mutual Funds have witnessed exponential growth and popularity in the past decade due to the convenience of investment and the growth opportunities that they offer.

For those of you who are new to the world of investment, there will be several questions that cross your mind – Questions ranging from something basic like what is an equity mutual fund and how does it work, to something more complex like what are the risks involved in equity mutual funds.

Thus, PersonalFN has put together this guide to answer all the frequently asked questions (FAQs), both basic and advanced, on Equity Mutual Funds. So read on…

What are Equity Mutual Funds?

Equity Mutual Funds are mutual fund schemes that invest predominantly in stocks of listed Indian companies. As per SEBI norms, a scheme must invest at least 65% of its assets in equity and equity-related instruments to be qualified as an equity mutual fund.

Equity Mutual Funds tend to generate higher returns compared to debt mutual funds and Bank fixed deposits, albeit at a relatively higher risk. Thus, investing in equity mutual funds is an ideal way to create long-term wealth for your various goals, such as retirement, children’s education/marriage, buying a dream home, etc. To find out the future value of your mutual fund investments check out PersonalFN’s Equity Mutual Fund calculator.

How do Equity Mutual Funds work?

Equity Mutual Funds invest the money pooled from investors into stocks of various companies spread across a range of sectors to create a diversified portfolio. Depending on its pre-defined investment objective, an equity mutual fund may invest predominantly in large-cap, mid-cap, or small-cap stocks or across market caps.

An equity mutual fund can be actively or passively managed. In the case of actively managed mutual funds, fund managers continuously track the portfolio. Then, based on the prevailing market conditions and micro and macroeconomic outlook, they decide which stocks/sectors to buy, sell, or hold. Actively managed schemes aim to generate returns higher than that of the market, and hence their returns may deviate from that of the benchmark index.

Popular Equity Mutual Funds in India

Data as of March 31, 2023
(Source: ACE MF) 

On the other hand, passively managed funds replicate the portfolios of certain indices, such as Nifty 50, Nifty 500, etc., to generate returns in line with the market.

[Read: ETF v/s Index Fund: Which is the Better Passive Investment Option?]

Furthermore, a scheme may follow a growth or value-oriented investment approach or a combination of both. Growth-oriented equity mutual funds invest predominantly in high-growth potential stocks. The fund managers may invest in such high-growth potential stocks even if they are trading at expensive valuations compared to their historical average.

On the other hand, value-oriented equity mutual funds aim to identify stocks that are trading below their intrinsic/fair value but are fundamentally strong and have the ability to grow and prove their worth. A combination of growth and value style of investing is a great diversification tool because if growth strategy moves out of favour, value investing can turn attractive, and vice versa.

Mutual Funds issue units to the investors in accordance with quantum of money they invest. Investors of mutual funds are known as unitholders.

The combined securities and assets the mutual fund owns are known as its portfolio, which is managed by qualified and experienced investment professional fund managers. Each unit an investor holds represents a portion of the portfolio. The value of the units held fluctuates with respect to the underlying value of the portfolio. The value of each unit is represented by the Net Asset Value (NAV) of the mutual fund.

The organisation that manages the investments is termed as the Asset Management Company (AMC). The AMC employs various employees in different roles who are responsible for servicing and managing investments.

The AMC offers various products (schemes/funds) in mutual funds, which are structured in a manner to benefit and suit the requirement of investors. Every scheme has an investment objective that they aim to achieve through judicious management of the portfolio.

How is the Equity Mutual Fund NAV calculated?

In simple words, NAV or Net Asset Value is the market value of the securities held by the Equity Mutual Fund scheme. Since the market value of securities changes every day, the NAV of the Equity Fund also varies on a day-to-day basis. The NAV of the fund is used to judge its performance.

NAV is the current market value of all the fund’s holdings minus liabilities, divided by the total number of units. For example, if the market value of all securities held by a mutual fund scheme is Rs 15 lakh, and the mutual fund has issued 1 lakh units to the investors, then the NAV per unit of the fund is Rs 15 (i.e., 15 lakh/1 lakh).

If an investor bought 100 units of the above fund at an NAV of Rs 10, his investment would now be worth Rs 1,500 (100 units* Rs 15 NAV). Or in other words, his mutual fund investment has grown by 50% (1,500/1,000-1).

Mutual fund houses disclose the closing NAV of each scheme after deducting expenses towards management, administration, and other costs, on a daily basis. All purchase and sale transactions of mutual funds take place at the closing NAV of the scheme.

What is the Expense Ratio in Equity Mutual Funds?

Fund management involves a lot of research and analysis to make the scheme successful. Apart from this, managing a mutual fund involves various costs relating to registrar and transfer fees, maintaining proper records of investors, custodian charges, brokerage on buying and selling securities, legal and audit fees, management expenses, advertising and marketing fees, etc. All these costs contribute significantly to a fund’s expenses.

Needless to say, like all service providers, mutual fund houses charge a fee for managing your money and providing related services. The fee that a mutual fund scheme charges is called expense ratio or total expense ratio (TER).

As an investor, you don’t pay this fee directly to the fund house, whether monthly, quarterly, or yearly. However, the fee is calculated on a daily basis as a percentage of the scheme’s total assets. Thus, the expense ratio will differ from one scheme to another. Every scheme discloses the daily NAV after taking into account the expenses incurred. There is no restriction on the type of expenses a scheme charges as long as the expense ratio is within the limit prescribed by SEBI.

TER = Total Expense/Total Assets

SEBI has framed rules related to the maximum expense ratio an open-ended or close-ended scheme can charge.

Mutual Fund TER limit for actively managed equity schemes

(Source: SEBI) 

So if a scheme handles an AUM of Rs 1 crore and incurs Rs 1.5 lakh in management, administrative, and other expenses, then the expense ratio will be 1.5%. SEBI has also prescribed the maximum TER limit that passively managed funds such as index funds, ETFs, and Fund of funds, as well as close-ended funds must follow.

What are the benefits of investing in Equity Mutual Funds?

Equity Mutual Funds offer several important advantages:

a) Long-term growth through diversification

Investing directly in stocks has one serious drawback – lack of diversification due to a large amount of capital needed to buy various stocks. Thus, many individuals end up holding only a handful of stocks in their portfolio. This can lead to considerable risk. With a concentrated portfolio, a decline in a single investment can have an adverse impact on your investments, damaging the returns of your portfolio.

An equity mutual fund, by investing in several stocks, tries to overcome the risk of investing in just 3-4 stocks. By holding say, 30 stocks or more, the fund avoids the danger of one bad stock negatively impacting the whole portfolio. Equity Funds own anywhere from a couple of dozen to more than a hundred securities, depending on the investment objective. What’s more? Equity mutual funds do not limit their investment to a particular sector or market cap, thus creating a portfolio that is truly diversified.

A diversified portfolio may thus fall to a lesser extent, even if a few stocks or investments fall dramatically. Also, a mutual fund’s NAV may certainly drop with market forces, but mutual funds tend to not fall as freely or as easily as stocks or other individually traded market securities. The legal structure and stringent regulations that bind a mutual fund do a very good job of safeguarding investor interest. Over the long run, this strategy enables equity mutual funds to generate healthy long-term returns.

b) Professional management

Active portfolio management requires not only sound investment sense but also considerable time and skill. By investing in an equity mutual fund, you as an investor do not have to track the prospects and potential of the companies in the mutual fund portfolio. Skilled research professionals appointed by the mutual fund house continuously research and monitor a wide list of companies.

c) Low ticket size

There are very few quality stocks today that investors can buy with Rs 5,000 in hand. This is especially true when valuations are expensive. In the case of mutual funds, the minimum investment amount requirement can be as low as Rs 500. Thus, with equity mutual funds, investors can start small and still get exposure to a diversified portfolio of 40-50 or more stocks.

d) Innovative plans/services for investors

By investing in the market directly, investors deprive themselves of various innovative plans offered by mutual fund houses.  For example, mutual funds offer automatic re-investment plans, systematic investment plans (SIPs), systematic withdrawal plans (SWPs), asset allocation plans, and triggers, among other tools that enable you to efficiently manage your portfolio from a financial planning perspective too.

These features allow you to enter/exit funds or switch from one fund to another, seamlessly – something that will probably never be possible in the case of direct investment in stocks.

e) Liquidity

A stock investor may not always find the liquidity in a stock to the extent they may want.

There could be days when the stock is hitting an upper/lower circuit, thus curtailing buying/selling. Further, if an investor is invested in a penny stock, he may find it difficult to get out of it.

On the other hand, mutual funds offer some much-required liquidity while investing. In case of an open-ended fund, you can buy/sell at that day’s closing NAV by simply approaching the fund house directly, or by approaching your mutual fund distributor or even by transacting online through your phone or laptop.

As highlighted above, investing in mutual funds has some unique benefits that may not be available to stock investors. However, by no means are we insinuating that mutual fund investing is the only way of clocking growth. This can also be done even by investing directly in the right stocks. However, mutual funds offer the investor a relatively safer and surer way of picking growth minus the hassle and stress of identifying when and which stocks to invest in.

On account of the aforementioned advantages which they offer, equity mutual funds have emerged as immensely popular asset class, especially for retail investor and for investors looking for growth with lower risks.

What is a Diversified Equity Mutual Fund?

A diversified equity mutual fund invests in a variety of stocks and is not focused on a single sector or theme for investment. Due to this diversification, diversified equity funds tend to be less volatile than sector/theme-specific funds. Hence, diversified funds are a preferred route for the majority of investors.

What are the types of Equity Mutual Fund schemes?

In 2018, mutual funds adopted SEBI’s categorisation norms for mutual fund schemes. Thus, under this regime, equity mutual funds have 12 different sub-categories.

In the table below, we have explained the characteristics of each category.

Here’s how the market capitalisation categories are defined by SEBI to ensure uniformity in respect of the investment universe for equity mutual fund schemes:

Large cap stocks:  First 100 companies on a full market capitalisation basis

Mid cap stocks:  All companies from 101st to 250th on full market capitalisation basis

Small cap stocks:  251st company onwards on full market capitalisation basis

For this, mutual funds are supposed to adopt the list of stocks prepared by AMFI that classifies them as large caps, mid caps, or small caps.

As per the new categorisation norms, only one scheme per category is permitted, except:

Index Funds/ETFs replicating/tracking different indices;

Fund of Funds having different underlying schemes; and

Sectoral/Thematic Funds investing in different sectors/themes

It means offering two different schemes within the same category won’t be permitted.

A fund house can offer more than one scheme in the sector and thematic category, but more than one scheme within each sector/theme is not permitted. For example, a fund house can offer one scheme each from each sectors, such as the Banking Fund, Consumption Fund, Pharma Fund, IT Fund, and so on.

Same is the case with index funds, ETFs and Fund of Funds too, provided they meet prescribed conditions.

Should prefer IDCW option or Growth option of Equity Mutual Funds?

Mutual Funds broadly offer two options – Growth and IDCW (erstwhile Dividend option). So, which is the most suitable option for you?

It is imperative that before you signify your choice of option, you are aware of what they mean and how they function.

Income Distribution cum Capital Withdrawal (IDCW) option – Under this option, a mutual fund scheme pays out a part of the dividend/gains from the underlying securities or the profits made by the scheme to the investors. This way, investors earn a regular flow of income. Do note that the NAV of the scheme reduces to the extent of the dividend paid.

Growth option – Under this option, the mutual fund scheme reinvests the dividends and profits earned from the underlying securities to enable compounding of wealth. This results in higher growth in NAV over the long run.

Now as far as the question of which is the correct option is concerned, it depends upon what your financial plan calls for. Your financial plan drawn by your planner should ideally be a function of your age, income, expenses, nearness to goals and risk appetite.

So say if you are young, your income is higher, your commitment towards certain expenses are lower, your willingness to take risk is high, and you are many years away from your financial goals, then you may opt-in for the growth option while investing in equity mutual funds. And remember, at a young age, since one generally doesn’t look for a regular cash flow (as generally, a regular income flows in the form of earnings), one should ideally optfor the growth option.

However, despite the financial planning aspects stated and the regular income earned, if you are still looking for a cash flow (in the form of a dividend) or want to book profits at regular intervals, then you may consider the IDCW option while investing in mutual funds.

Are dividends on Equity Mutual Funds taxable?

Income received by the investor as IDCW is added to their gross taxable income and taxed according to the income tax slab rate they fall under. Therefore, from a taxation viewpoint, too IDCW is at a significant disadvantage over the growth option, particularly for investors in the higher tax brackets. TDS is also applicable on IDCW if the total dividend amount exceeds Rs 5,000 in a financial year.

Direct Plan or Regular Plan of Equity Mutual Funds: Which is the better way to invest?

Almost all mutual funds offer you broadly two plans to invest in their schemes, namely Direct plans and Regular plans.

Direct Plan – Opting for this plan while investing in mutual funds, you eliminate the services of a mutual fund distributor/agent/relationship manager. The transaction may be performed online or even physically by visiting the registrar’s or the asset management company’s office.

Regular Plan – This has been the conventional way wherein you push your request to transact vide mutual fund distributor/agent/relationship manager.

Direct plans offered by mutual funds make a positive difference to your investments every year. The direct plans generate roughly 0.5% to 1.0% additional returns every year. However, if you sow seeds of these small savings, you may harvest rich rewards over 15- 20 years – thanks to the power of compounding.

[Read: Even 1% Difference Can Make A Huge Difference To Your Investments]

There’s another benefit of investing through direct plans. You can easily avoid commission-driven distributors and agents who might misguide you. You get a chance to do your research on available investment options.

But many investors find this job very tedious and time-consuming. If this has been your reason for not investing, it’s time you re-examine. Many platforms offer you ready tools to compare equity mutual funds just at a click and control of the mouse.

Alternatively, you can always seek the help of an independent mutual fund advisor who offers an unbiased research-based view for a fee, and you’re always free to invest in a direct plan. For your long-term financial wellbeing, it is essential that you review your portfolio so that corrective measures can be taken at the right time.

Mutual fund direct plans make a positive difference to your investments every year. These plans generate roughly 0.5% to 1.0% additional returns every year, thanks to lower costs. It may not seem much at first, but if you sow seeds of these small savings, you may harvest rich rewards over 15- 20 years – thanks to the power of compounding.

Direct plans allow you to save huge costs over the long term

(Source: PersonalFN Research) 

As we can see in the chart above, a small difference in costs can result in savings of anywhere between Rs 8-17 lakh over 20 years on a Rs 10 lakh investment. Yes, you can earn an additional amount of as much as Rs 17 lakh if the difference in costs is as much as 1% point. The final portfolio value varies with the magnitude difference in expenses. Every 0.25%-point difference in the expense ratio works out to an additional earning of Rs 4.50 lakh in 20 years’ time if Rs 10 lakh is invested.

This Rs 10 lakh investment is just an assumption. In reality, if you are saving for your long-term goals, such as retirement, you will be targeting a corpus of over Rs 1 crore for sure. Just imagine the costs then. Surely, you do not want to lose your hard-earned money in the form of costs that can be easily avoided. Moreover, the additional saving to such an extent can make a huge difference to your financial goals.

Are Equity Mutual Funds risky?

As equity mutual funds invest majorly in equities, they are susceptible to market volatility. If the equity market is declining, your equity mutual fund will likely move in the same direction, and vice versa. This movement is reflected in the Net Asset Value (NAV) of a respective mutual fund scheme which will fluctuate in line with the movement of the underlying securities.

Due to the volatile nature of the equity market, equity mutual fund returns are not fixed or guaranteed. The schemes may generate negative returns during certain market phases and high returns during others.

The intensity of risk varies from one sub-category to another. Certain sub-categories, such as Large Cap Fund, Flexi Cap Fund, and Value Fund are relatively less volatile compared to Mid Cap Funds and Small Cap Fund.

[Read: 4 Best Equity Mutual Funds to Invest in a Volatile Market]

Apart from this, certain sub-categories such as Sector/Thematic Fund may expose investors to concentration risk due to lack of diversification.

Risk-Return Spectrum of Equity Funds

(For illustration purpose only) 

That said, the risk can be mitigated if you invest over the long term regardless of the market conditions and maintain a diversified portfolio of funds that aligns with your investment objective and risk profile.

Who should invest in Equity Mutual Funds?

Equity Mutual Funds are suitable for investors aiming to achieve various long-term goals such as retirement, children’s education/marriage, buying a house, etc. If you are looking to earn market-beating returns that can outpace the returns generated by traditional investment avenues such as Bank deposits and small saving schemes, investing in equity mutual funds can be your best bet. Ensure that you have the appetite to handle the ups and downs of the market, as equity mutual funds can witness bouts of sharp volatility and market corrections. Moreover, you should have an investment horizon of at least 3-5 years to derive the full potential of your equity mutual fund investment.

What is the SIP mode of investing in Equity Mutual Funds?

A Systematic Investment Plan (SIP) is a mode of investing in mutual funds that allows you to invest in a systematic and regular manner. The method of investing is similar to your investment in a Recurring Deposit (RD) with a bank, where you deposit a fixed sum of money (into your recurring deposit account), but the only difference here is your money is deployed in the equity mutual fund of your choice and not in a bank deposit, and hence your investments are subject to market risk.

An SIP enforces a disciplined approach towards investing and infuses regular saving habits that we all probably learnt during our childhood days when we used to maintain a piggy bank. Yes, those good old days when our parents provided us with some pocket money, which after expenditure, we deposited in our piggy banks and at the end of particular tenure, we saw that every penny saved became a large amount.

SIPs, too work on the simple principle of investing regularly regardless of the market conditions, which enable you to build wealth over the long term. This makes SIP less risky than investing a lumpsum amount wherein you may have to time your investment. In case of SIPs, on a specified date which can be on a daily basis, monthly basis, or on quarterly basis, a fixed amount, as desired by you, is debited from your bank account (either through an ECS mandate or through post-dated cheques forwarded) and invested in the scheme as selected by you for a specified tenure (months, years).

Today some Asset Management Companies (AMCs) / mutual fund houses / online platforms / mobile apps also provide the ease and convenience of transacting online. They have set up their own online transaction platforms, where one can start SIP investments by following a few simple steps.

So, you have fewer hassles while investing as well as tracking your investment dates.

To calculate the future value of your SIP investments you can use PersonalFN’s SIP calculator.

Which are the best Equity Mutual Funds for SIP?

When market sentiments are high, investors often go scouting for the best equity mutual funds to invest in. However, one should not get lured by past returns years when selecting best equity mutual funds to invest in. Investors need to adopt a cautious approach.

Instead of chasing the best-performing funds or the top-performing funds, you need to take a step back and ensure to pick the right equity mutual, which is much more important for your financial wellbeing.

Invest as per your financial plan that’s been drawn up after evaluating aspects such as your age, risk profile, financial health, investment horizon, financial goals and so on.

[Read: Are You Setting Your Risk-Return Expectations Right While Investing in Mutual Funds?]

If you have a financial plan in place, stick to it. If not, you should invest as per your risk profile below:

i) Mutual fund categories for 3 to 5 years

Investors with a time horizon of 3 to 5 years can explore pure equity mutual fund avenues. However, the time frame is not sufficient to assume a higher risk. Therefore, it is important to balance the risk with some debt component.

Consider relatively stable equity-oriented categories such as Large-cap Funds, Flexi-cap Funds, along with hybrid mutual funds such as Aggressive Hybrid Fund or Balanced Advantage Fund.

Decide the weightage in each of these schemes based on your risk tolerance. For instance, investors with a moderate risk profile can have higher exposure to Large-cap Funds and Hybrid Funds but lower allocation to Flexi Cap Funds. This is because Flexi Cap Funds have the flexibility to increase their allocation to mid-cap and small-cap stocks if it has a positive outlook on the segment.

Similarly, if you are averse to taking higher risk, you can skip investing in Flexi Cap Funds altogether.

ii) Mutual Fund categories for 5 to 7 years

This is an ideal time horizon for investors seeking high returns from high risk, but not ideal for investments with very high risk. You can allocate money in categories such as, Large-cap Funds, Flexi-cap Funds, Mid-cap Funds, Large & Midcap Funds, Value Funds, and Aggressive hybrid Funds.

Assigning appropriate weightage in these categories can give your mutual funds portfolio the power to generate high alpha over the long term. It will also give you the benefit of diversification across market caps and enable you to earn optimal risk-adjusted returns.

As mentioned, it is important to allot weights in these categories after assessing your risk profile. Limit your exposure in relatively risky categories such as Mid-cap Fund and Large & Midcap Funds if you do not have the appetite for higher risk.

iii) Mutual fund categories for 7+ years

A horizon of 7 years or more is sufficient for equity mutual fund investors looking to realise long-term goals by following an aggressive approach. However, you still need to allocate money in different categories based on your needs and diversify to mitigate the impact of volatility.

Even if you are an aggressive investor, Large-cap Funds should form a part of your core portfolio. Along with Large-cap Funds, you can consider adding Flexi-cap/Multi-cap Funds, Mid-cap Funds, and Small-cap Funds. Remember that even for very long-term goals, it is not advisable to go overboard with your investment in Mid-cap Funds and Small-cap Funds.

Moreover, to boost your returns over a period of time, you can consider diversification towards International Funds and/or Sectoral & Thematic Funds. But ensure that the allocation to these funds does not exceed 15% to 25% of your entire mutual fund portfolio.

Equity Mutual Funds vs Debt Mutual Funds

Your personalised asset allocation plan is a key factor to decide whether you should invest in equity mutual funds or debt mutual funds or both.

As mentioned earlier, equity mutual funds are suitable for investors with moderate to high risk appetite and long-term investment horizon of at least 3-5 years.

But if you have a low risk appetite and an investment horizon of less than 3-5 years, you may want to avoid equity-oriented funds altogether. Instead, you may consider hybrid funds or debt mutual funds.

Debt mutual funds are schemes that predominantly invest in fixed-income generating instruments such as corporate bonds, government bonds, certificates of deposits, treasury bills, etc. These funds aim to provide diversification and stable returns as they are less volatile compared to equity mutual funds. This makes debt mutual funds suitable for investors with a low risk profile and a short to medium-term investment horizon.

So, if you are a conservative investor and your investment horizon is less than three years, then you should avoid equity exposure. You can look at relatively safer debt mutual fund categories such as Overnight Funds, Liquid Funds, Ultra Short Duration Funds, Bank & PSU Debt Funds, Corporate Bond Funds, and/or Bank deposits.

If you are willing to take slightly higher risks, you can consider investing in Conservative Hybrid Funds. These funds are more inclined towards debt instruments (75% to 90% of its assets) and come with a small equity allocation (10% to 25% of its assets) to boost returns, as compared to pure debt schemes.

Investors with moderate risk profile consider investing in Arbitrage Funds. These funds take exposure in hedged equities (derivatives), which makes it less volatile than pure equity mutual funds and other hybrid mutual funds. Ensure that you have an investment horizon of at least 6-12 months so that the fund managers have sufficient time to explore arbitrage opportunities.

How to select the top Equity Mutual Funds for SIP?

There are a plethora of equity mutual funds available in the market, and thus, it can be a challenging task to select the best equity mutual funds for SIP. Many individuals prefer to take the easy way out and select the scheme based on its popularity, while others pick the one with the lowest NAV. Few others simply select the top-performing schemes of the previous year.

However, these are imprudent ways to select the best equity mutual fund for your portfolio that may fail to pay off in the long run. To select the best schemes from each category, it is important to assess them on various qualitative and quantitative parameters as mentioned below:

I. Quantitative parameters

1) Past performance

The core objective of investing in equity mutual funds is to maximise wealth by investing in a diversified basket of stocks spread across sectors and market caps. Accordingly, it makes sense to analyse the past performance of the scheme, which will help you set realistic expectations of its future performance.

However, when you evaluate a fund’s past performance, ensure that you do not give undue importance to this aspect while shortlisting schemes for selection because past performance is not indicative of how the fund will perform in the future. Instead, you should use past performance as a tool to determine how consistently the scheme has performed. Here is how you can do it:

Compare performance against the category peers and the benchmark index:  Assess the performance of the scheme relative to its benchmark and the category peers across various time frames such as 1-year, 3-year, 5-year, 7-year, since inception, etc. If a particular fund does not have a long-term track record or has generated a one-off superior performance, it may be better to ignore it.

Evaluate the fund’s performance across market cycles:  Most mutual funds perform well during market uptrends. However, when the market conditions look bleak, many funds fail to contain the downside. Therefore, it is vital to select schemes that perform consistently well in most bear and bull market phases relative to their benchmark and the category peers.

2) Risk-adjusted returns

Since equity mutual funds invest predominantly in equities, they are susceptible to market volatility. However, the impact of volatility can be mitigated if the fund manager deploys efficient risk-management techniques. To determine a scheme’s ability to reward investors adequately for the level of risk taken, you should evaluate the scheme’s Standard Deviation, Sharpe Ratio, and Sortino Ratio.

3) Portfolio quality

The performance of an equity mutual fund is extensively dependent on the quality of its underlying portfolio, i.e., stocks, sectors, and market cap allocation. If the underlying securities do well, your mutual fund scheme is likely to reward you with superior returns. Therefore, ensure that the scheme is well-diversified across stocks and sectors to avoid concentration risk. To assess this, analyse the scheme’s top-10 holdings, the top-5 sector exposure, the market capitalisation bias, and the investment style followed — value, growth, etc.

II. Qualitative parameters

Qualitative parameters are often overlooked, but they play an equally important part in selecting the right equity mutual fund for investment.

Quantitative factors are easy to find and analyse while selecting mutual funds. But the real art is to discover and analyse the qualitative factors. It involves determining the quality and efficiency of the fund house and the fund management team because only process-driven funds can be expected to generate consistent returns for investors.

Analyse the below factors to determine if the fund scores high on qualitative parameters:

1) Efficiency of the mutual fund house

When you select equity mutual funds for your portfolio, always give higher importance to fund houses that follow sound risk management techniques and have robust investment systems and processes in place. It is crucial that you understand the overall philosophy of the fund house, whether they aim to create wealth for investors or are they in a race to garner more AUM by showcasing higher returns generated by chasing higher yields and taking higher risk.

2) Experience of the fund manager

The performance of an equity mutual fund is directly dependent on the ability of its fund manager to timely identify various opportunities available in the market. This makes it crucial to check the qualification and experience of the fund manager and the track record of the other schemes they manage. Apart from knowledge and market experience, assess the number of schemes that they manage.

Does investing in Equity Mutual Funds help you save tax?

Individuals can claim a deduction of up to Rs 1.50 lakh under Section 80C of the Income Tax Act if they opt for the old tax regime. There is a wide range of investments that qualify for a deduction, such as Public Provident Fund (PPF), 5-year Tax-saving Bank Fixed Deposit, Equity Linked Saving Schemes (ELSS) of mutual funds, National Savings Certificate (NSC), etc. You can claim an additional deduction of up to Rs 50,000 if you have invested in the National Pension Scheme (NPS).

Those who do not mind the high risk of equity investments prefer to invest in ELSS among all the other tax-saving products. Compared to other tax-saving products, ELSS are the most liquid due to the shortest lock-in period of three years. They are also among the riskiest. When investing in ELSS, you should keep a long-term investment horizon of five years or more. By keeping a long-term investment horizon, you can benefit from compounding that would help multiply your wealth.

There is no dearth of choices in the ELSS mutual fund category. Hence, you need to analyse the fund performance minutely before investing. Remember that under ELSS, the lock-in is three years. Thus, if you pick the wrong fund, you will have to bear the cost of underperformance for the entire period.

[Read: Why ELSS Is Your Best Choice to Build Wealth and Save Tax]

The performance of ELSS funds can vary wildly over the years. A top ELSS fund in one period may not necessarily be the best ELSS fund for the next period. Thus, you need to pick the right ELSS fund, one that has performed consistently and one that has generated a superior risk-adjusted performance.

When selecting ELSS, or any mutual fund for that matter, you need to choose wisely and look for consistency in performance. You also need to pay heed to your tax planning needs. While there are a host of provisions under the Income Tax Act and numerous investment avenues, you need to identify and select the most suitable investment avenue that will help you to save tax in a prudent way.

While we acknowledge that even the best systems and processes cannot predict the top ELSS funds of the future, as an investor, you need to pick the right and suitable ELSS funds to meet your financial goals.

Equity Mutual Funds Vs Direct Stocks – Which is better?

Within the domain of investments, two options that investors regularly dabble with are stocks (i.e., direct equity investing) and mutual funds. Both have their advantages, although this note does not get into that debate. Instead, in light of the present discussion about investing being a full-time activity, let’s see how stocks and mutual funds face off against one another-

1. A matter of time

Investing directly in the stock markets is a full-time activity. It may sound like a one-time activity, but trust us, it isn’t. There is research to be done pre-investment and pre-disinvestment. And research on a company does not just involve knowing its business. The investor is expected to master several subjects, i.e. prospect of the sector, other companies operating in that sector and how the company (under review) is superior to them. The investor is also expected to study the economic and political climate of the country to gauge the bearing they can have on the sectors and companies in them. Having done this research before investing, the investor is expected to continue doing it even after one has invested in it so as to ensure he/she is invested in the right company/companies.

However, if you believe that if you have the time and expertise to invest and regularly monitor your portfolio, then consider investing in equities directly. Conversely, investing via the mutual fund’s route is far less time-consuming. Sure, it might take a while to assess your asset allocation needs and select the right mutual funds; however, beyond that, a better part of the responsibility lies with the fund manager.

2. Investing skills 

If you have the time to take up investing, then you have cleared the first hurdle. But there are other hurdles to be cleared, i.e., investment skills. Successful fund manager hasn’t got where they have only because they have the time to invest; they have something even more scarce — the skill and knack of investing. And the skill sets to invest are not acquired overnight. Fund managers earn their stars over the years after going through several market trends and cycles (ups and downs) and after making several mistakes. So apart from the time factor, investing demands a lot of skill and experience.

3. Access to research

Most investors who wish to take up investing as a full-time activity are likely to hit a roadblock in getting unrestricted access to quality research. While conventional wisdom suggests that the annual report should prove sufficient in this regard, the bad news is that the annual report is just the starting point. For more information, you have to read up extensively on sectors and companies in those sectors. While some of this information could be available for free (in libraries or on the internet, for instance), the quality inputs (read updated and insightful research) are usually available for a stiff fee.

Mutual fund managers, on the other hand, have no problem with these issues. For them, accessing research (regardless of the price) is never a problem. Meeting up with the company management and industry bigwigs is something they do on a regular basis. In fact, investment decisions are rarely taken without these inputs. On the other hand, the layman investor will often be compelled to take an investment decision devoid of these inputs. It is not surprising then that there is usually a wide chasm between the quality of investments across both these categories (fund managers and layman investors).

Furthermore, when you invest in equity mutual funds, avoid doing it with the mind of trader. If you frequently buy/sell equity mutual funds like stocks, it can lead to following consequences:

1. It can put a brake on the process of compounding wealth, which may negatively impact the overall growth of your investment portfolio.
2. Frequent trading attracts taxes and exit load, which can eat into your overall returns.
3. You may end up earning lower returns than expected, which in turn, can create a hurdle in achieving your financial goals.

What is the tax implication of Equity Mutual Fund investments in India?

Capital gains on sale of equity mutual fund units are taxable like most other investments. The holding period for equity mutual funds from a tax perspective is 12 months. So, if you sell your equity mutual fund units before 12 months, you pay short-term capital gains (STCG) tax of flat 15%.

On the other hand, if you sell your equity mutual fund units after completing one year, you pay a long-term capital gains tax of 10% with indexation, but only if your gains exceed Rs 1 Lakh in a financial year. If your long-term gains are below Rs 1 Lakh and you redeem after completing one year, then you do not have to pay any tax on these gains.

What is the Equity Mutual Fund taxation for NRIs?

For NRI investors, the tax implications are similar to that of a resident investor. Hence, for equity mutual funds, capital gains for NRI Investors is 15% for STCG and 10% for LTCG (exceeding Rs 1 lakh). However, in the case of NRIs, tax is deducted at source (TDS) by mutual fund houses. The Finance Bill 2023 proposed that the fund houses can charge TDS depending on the tax treaty with the NRI’s host country or 20%, whichever is less. At present, fund houses can apply TDS at 30% from NRIs.

How to invest in Equity Mutual Funds: Offline & Online?

You can invest in mutual funds offline by visiting the nearest branch of a mutual fund house or a mutual fund distributor and submitting a duly completed application form along with other relevant documents such as proof of identity, proof of address, cancelled cheque leaf, and paying the required investment amount.

Or else, you can choose to invest in mutual funds online from the comfort and convenience of your home. There are different ways to invest in mutual funds online…

1) How to Invest in mutual funds online directly with the AMC?

You can buy mutual fund units online directly from the Asset Management Company’s (AMC’s) website. Before you proceed, you need to check whether you are KYC compliant. You can complete the KYC process online with OTP-based Aadhar authentication if you are a new investor.

Once the KYC process is complete, you can proceed to invest in the scheme you are interested in by following the below process:

• Open a new account with the AMC by providing relevant personal details
• Fill in the required investment details such as:-

– Selecting the desired scheme

– Select the plan type (Direct) and option (Growth or Dividend)

– Mode of investment — one-time payment or SIP, etc.

– Enter the investment amount and frequency (in case of SIP)

• Provide bank details and mode of payment — net banking, debit card, etc.
• Verify and complete the transaction

Do note that if you are investing in schemes belonging to different AMCs, you will have to perform the same procedure with each AMC. This could make the investment process complex and time-consuming.

The Registrar & Transfer Agents (RTAs) of mutual funds such as CAMS and KFintech also facilitate online investing. However, the investment will be limited to the AMCs serviced by them.

2) How to invest in mutual funds online through a Demat Account?

If you have an existing Demat Account, you can use it to transact in mutual funds online. All you have to do is log in to your Demat account and look for the option to invest in mutual funds. Then select the scheme you want to invest in and enter the investment amount to complete the transaction. Once the process is complete, the mutual fund units will be credited directly to your Demat account. Do note that once you hold mutual funds in Demat form, all transactions (including stopping or redeeming investments) will have to be done only through the Demat Account.

The benefit of investing in mutual funds through a Demat Account is that it is a convenient option to invest and track all your mutual funds, equities, and bonds in one place. However, additional charges may be applicable when you invest in mutual funds through a Demat account, such as annual maintenance charges, transaction charges, etc.

3) How to invest in mutual funds online through investment platforms?

Investment in mutual funds can be made online in an easy and hassle-free way through investment platforms. Mutual Fund investment platforms such as “PersonalFN Direct” offer single-point access to help you with investing and tracking your transactions with different AMCs.

The following steps are required to invest online using a mutual fund investment platform:

• Create an account with the mutual fund investment platform
• Fill in a few personal details such as name, PAN, Aaadhar, and bank details
• Select the scheme you wish to invest in (you can select multiple schemes)
• Choose the mode of investment (SIP or lumpsum) and the amount
• Make the payment to complete the investment

This article first appeared on PersonalFN here