Benefits of investing in equity funds
Introduction
Mutual funds can be broadly classified into three types – equity, debt, and hybrid. Each asset class comes with its own risk and return profile. While equity mutual funds invest in shares and stocks of different companies, debt mutual funds focus on fixed-income securities. Hybrid funds, on the other hand, invest in a mix of equity and debt.
In this article, we will learn about equity mutual funds, their benefits, and their suitability for different types of investors.
Seven key benefits equity funds
Here are seven key advantages of investing in an equity fund:
High return potential
Equity mutual funds are the riskiest among all types of mutual funds, but they also offer the highest potential for returns. These funds invest in the stocks of companies, which can be highly volatile in the short term. However, over time, they tend to recover from market fluctuations and may perform well in the long run.
Wealth creation
Equity funds are ideal for long-term wealth creation. The power of compounding can convert even a small sum into a large amount over time. This is because the returns earned are reinvested in the fund, so you earn gains not only on the principal but also on previously earned returns, leading to the creation of a substantial corpus over the years.
Diversification
Despite investing in equities, these funds offer diversification. Equity mutual funds are further classified into different sub-categories, giving you exposure to various companies across market capitalisations, investment styles, sectors, and themes.
The sub-categories are as follows:
- Multi Cap Fund
- Large Cap Fund
- Large & Mid Cap Fund
- Mid Cap Fund
- Small Cap Fund
- Dividend Yield Fund
- Value Fund
- Contra Fund
- Focused Fund
- Sectoral/Thematic Fund
- ELSS (Equity-Linked Savings Scheme)
Tax benefits
There are several benefits of mutual funds, and tax benefits are one of them. ELSS is an equity-oriented mutual fund that offers tax-saving opportunities under Section 80C of the Income Tax Act if you opt for the old tax regime. It allows you to claim a deduction on investments up to ₹1.5 lakh annually. Additionally, since ELSS has a mandatory lock-in period of three years, your gains on redemption will, by default, be subject to a Long-term Capital Gains (LTCG) tax rate of 12.5% instead of the short-term rate of 20%. Moreover, LTCG up to ₹1.25 lakh per year are tax-free.
Liquidity
Except for ELSS, which has a lock-in period, all open-ended equity mutual funds can be redeemed at any time. That said, you must pay attention to any exit loads and tax implications when withdrawing your investments.
Professional management
Professional management is one of the key benefits of investing in mutual funds. Investing directly in stocks requires good market knowledge, enough time to research and pick promising securities, and access to a demat and trading account. On the other hand, equity mutual funds are managed by professional fund managers who have years of experience. They invest on your behalf with the goal of maximising returns.
SIP option
A Systematic Investment Plan (SIP) is also one of the key benefits of mutual funds. Like other mutual funds, equity funds allow you to invest in a lump sum or through SIPs, where you invest a fixed sum at regular intervals.
SIPs offer several benefits, such as financial discipline and affordability. However, their biggest advantage is rupee cost averaging. You invest consistently during different market cycles. While your investment amount remains the same, you get more units when prices are low and fewer units when prices are high. This averages out your investment cost over time.
Who should invest in equity mutual funds?
Equity funds may be suitable for the following types of investors:
Those with a high risk appetite
Equity funds come with a high return potential but also carry high risk. Thus, they are suitable for aggressive investors who have high risk and volatility tolerance.
Young investors
As a rule of thumb, the younger you are, the higher your equity allocation can be. When you are young, you can invest aggressively because you are likely to have fewer financial obligations, and you will also have enough time to stomach and recover from market downturns.
Those seeking long-term wealth creation
Wealth creation is a marathon that requires patience, consistency and a long horizon. Investing regularly in equity funds can help generate inflation-beating returns over the long term.
New investors wanting to explore the potential of equities
Unlike direct investing, equity funds offer professional management. Mutual fund SIPs further help tackle the risks associated with equity by spreading the investment over time.
Five tips for successful investment
While the high returns are never guaranteed, you can improve your investment outcomes by following these five tips:
Consider individual factors
Before choosing an equity fund, evaluate your financial goals, investment horizon and risk appetite. Such funds may not be suitable if you are a risk averse investor or have short-term needs.
Analyse fund-specific factors
Assess factors such as the past performance of the fund, the track record of the fund manager, the reputation of the fund house, the expense ratio and other charges to make well-rounded decisions.
Diversify your portfolio
Invest in different types of equity funds to balance risk and return. If one fund underperforms, gains from other funds can help stabilise the overall portfolio.
Invest for the long term through SIPs
Equities need time to perform and generate strong returns. SIPs encourage long-term investing as they spread your financial commitment over time and reduce your investment burden.
Monitor your portfolio regularly
Review your portfolio periodically to ensure your investments are on track and aligned with your financial goals. Rebalance, if necessary, to maintain the desired asset allocation.
Conclusion
Equity mutual funds are high-risk, high-return investments best suited for long-term investors with a high risk appetite. There are many benefits of equity funds, such as professional management, diversification, and liquidity. However, it is essential to analyse your financial goals and risk appetite before making an investment decision.
SIPs let you invest small amounts regularly, making it easier to stay consistent with your goals. With time, your money grows faster through compounding, helping you get the most out of your investments. Try our SIP Calculator to see how your money can grow and make smarter plans for your future
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