Equity Mutual Funds

Equity mutual funds are those that invest at least 65% of their assets in listed domestic equity and related instruments.

They are considered to be wealth-creation instruments for long-term investors. 

Long-term because stocks (the underlying assets of equity mutual funds) are volatile, especially in the short-term, but have historically generated higher returns than traditional instruments like FDs in the long-term.

Let’s look at various aspects of equity mutual funds like types, advantages and taxation.

Equity mutual funds can be categorised into different types based on the following 4 factors:

1. Market capitalisation
2. Diversification
3. Investing styles
4. Sectors and themes
5. Solutions

Market capitalisation

Market capitalisation, loosely speaking, is an indicator of the size of the company. 

It is generally observed that stocks of large cap companies are more stable than the stocks of relatively smaller companies. This means their prices rise/fall at a slower pace than stocks of relatively smaller companies.

Popular equity mutual fund categories based on market capitalisation are:

1. Large cap mutual funds
2. Mid cap mutual funds
3. Small cap mutual funds

Diversification

More generally, diversification refers to investing in different types of assets and instruments to reduce the risk of the investment portfolio.

However, among equity mutual funds, diversification refers to investing in stocks of companies that are from different market capitalisation and sectors.

Flexi-cap mutual funds are among the most popular equity mutual fund categories based on diversification.

Investing style

In equity investing, investors/fund managers are biased towards certain investing styles. 

Value investing, the investing style of Warren Buffet, is among the most popular ones. It involves identifying and buying stocks that are mispriced by the market and hence available at a discount to its intrinsic value.

Popular equity mutual fund categories based on investing style are:

1. Value funds
2. Contra funds
3. Focused funds

Sectors and themes

Certain sectors (like FMCG) or themes (like consumption) tend to perform better than the rest of the market during certain periods. Sectoral and thematic mutual funds help investors leverage this.

However, they are also quite risky as sectors/themes could underperform the market significantly for long periods too. 

Popular sectors/themes that equity mutual funds track are:

1. Technology
2. Banking
3. Pharma

Solutions

Some mutual funds are marketed for specific solutions like tax-saving, retirement and children’s goals.

Tax-saving mutual funds are among the most popular equity mutual funds. This is because individual investors can enjoy tax deduction of up to Rs. 1,50,000 per financial year under IT section 80C with a short lock-in of 3 years.

Investing in equity mutual funds can be a rewarding experience if done right. 

This is because they enjoy some significant advantages over traditional instruments like FDs and even against investing in stocks directly.

Here are the top 3:

Diversification and professional management reduces investment risk

Equity mutual funds invest in dozens of stocks that are carefully picked by fund managers who are generally highly qualified investment professionals.

Diversification across many stocks and oversight from investment professionals help reduce the risk of investing in equity, a relatively volatile asset class.

Higher potential returns than fixed income instruments like FDs

Equity has an impressive track record of generating higher returns than low-risk fixed income instruments like FDs (fixed deposits).

Moreover, as of Oct 2023, the effective tax rate on equity mutual fund gains is lower than the effective tax rate on fixed income instruments (like FDs) for investors in higher tax brackets (20% and above).

However, these advantages come with the added risk of investing in equity. A long-term commitment and investing discipline is required to lower equity investing risk and generate the expected returns.

Better taxation treatment than investing in stocks directly

When you invest in stocks directly your gains and dividends are taxed as and when you realise them. This slows down the long-term compounding of your portfolio value.

However, when a mutual fund realises gains and receives dividends from the underlying stocks, they are not required to pay taxes on them. This is because mutual funds are set up as trusts. 

This effectively means equity mutual funds deliver uninterrupted compounding of your money.

Capital gains arising from equity mutual funds are taxable. The tax rate applicable depends on how soon the capital gains are booked after your investment.

Here is how equity mutual fund taxation works for investors who are resident Indians:

STCG on Equity Mutual Funds

If you book capital gains within 1 year of your investment, they are categorised as ‘short-term capital gains’ also known as STCG and subject to STCG taxation.

The tax rate applicable on short-term capital gains arising from equity mutual funds is 15%. Entire gains are taxed without any exemption.

LTCG on Equity Mutual Funds

If the capital gains are booked after 1 year of investment, they are categorised as ‘long-term capital gains’ also known as LTCG and subject to LTCG taxation.

The tax rate applicable on long-term capital gains arising from equity mutual funds is 10%. However, the first ₹1,00,000 of LTCG is exempt from tax every financial year. 

For example - If you book Rs. 1,10,000 of LTCG from your equity mutual funds, only ₹10,000 is subject to LTCG taxation. This means you pay only ₹1,000 (10% of ₹10,000) LTCG in that financial year.

Tax on Dividends from Equity Mutual Funds

Dividends are received from equity mutual funds when you invest in their IDCW (Income Distribution Cum Withdrawal) option.

Dividends received on equity mutual funds are taxed at your marginal income tax rate.

Note: Tax Deducted at Source (TDS) is applied on dividends received in excess of Rs 5,000 per AMC per financial year.

Equity mutual funds are significantly more volatile compared to traditional investment options like fixed deposits and provident funds.

However, they also have an impressive track record of generating high, inflation-beating returns over the long term (more than 10 years)

How to Invest in Equity Mutual Funds?

Dezerv’s app is among the best apps in India to invest in equity mutual funds. 

In fact, Dezerv offers well-diversified mutual fund portfolios with the right mix of equity mutual funds and debt mutual funds.

Why should you invest in equity mutual funds on Dezerv?

✅ Investment portfolios designed by experts

✅ Diversification helps keep investing risks low

✅ Portfolios for short-term and long-term

✅ Optimise portfolio regularly through rebalancing

✅ 100% digital account opening and investment process

Download the Dezerv App ->