Capital Appreciation - Invest in Equity mutual funds

Mutual Fund offers many types of investments that have evolved in the last few years. Based on investor’s risk appetite and ease of understanding, SEBI has divided various mutual fund schemes into different categories. An Equity fund is one among these categories. In this article, let us explore equity mutual funds that relatively provide high returns but also possess high risk.

What are equity funds?

Investing in Equity mutual funds means guided and careful investment in the share market with the help of an expert. A fund manager invests the mutually collected corpus to buy shares of different companies. The returns from these shares vary with the market. Equity funds returns completely depend on the market level. If the market is high, returns earned are higher and vice-versa. As you cannot time the market, the risk of equity funds is always high.

Why invest in equity funds?

   1. Good returns compared to other assets to beat inflation

Compared to other investments, equity mutual funds have historically beaten inflation. For long-term investors, investing in equities is the best way to stay ahead of the inflation rate.

   2. Diversified portfolio

Equity mutual funds provide a platform where the investors can hold multiple stocks and shares of different companies from various themes, sectors, etc. Holding a wide range of stocks helps investors to overcome the losses in one stock by profits from other stocks.

   3. Capital appreciation

Equity mutual funds are a good option for those investors who are interested to grow their capital over the medium to long term say 7-10 years. When a company makes profit, it results in increased price of the company stocks. When the stock price increases, it gets reflected as capital appreciation for the invested money.

   3. Tax benefits

Investment in ELSS saves you up to Rs. 1,50,000 from annual taxable income every year. ELSS is the only tax saving investment that has shown consistently high returns. In case, of before a year, short-term capital gain tax is levied at the rate of 15%. Similarly, long term capital gain tax is levied on equity funds at the rate of 10% if the capital gains exceed Rs 1 lakh a year (suppose, you earned profit of 3 lakhs, then you need to pay tax on 2 lakhs only).

   4. Professional management

Investing in equities demands regular market study to evaluate better investment opportunities. As individual investors, one is required to spend lot of time on research and analysis. Mutual fund companies hire experts having vast experience in stock market and company performance. They mitigate risk by doing extensive research and analysis on companies.

   5. Liquidity

Stocks are traded regularly in all major exchanges facilitating the investors to sell a portion of units or entire units at any time. For example, in any open-ended equity mutual fund, you can redeem the investments any time to meet your emergencies. In case of mutual fund, it takes nearly 3-4 days to receive amount in your account.

Working of equity funds

A fund manager invests the mutually collected corpus in equity stocks. The following are some essential factors to consider before investing in equity mutual funds.

   1. Diversification

A fund manager divides the total corpus and invests in different assets. 80-85% of the total corpus is invested in equities and the rest portion of the total corpus is invested in debt funds or money market instruments. This way, a fund manager invests a total corpus to achieve high returns.

   2. Investment objective

The majority of the investments take place with a purpose. You need to select funds that align with your investment objectives and match them with your risk appetite. The investment objective of all equity funds is capital appreciation, but the risk taken to achieve this common investment objective may vary depending on investment time-horizon.

   3. Investment style

It is imperative for the investors to understand stock selection methodology;

   4. Expenses

There is cost of managing these funds and fund house charges few percentages points to the fund as expenses. These charges are termed as the expense ratio. It includes various costs such as administrative cost, investment management charges, marketing and distribution cost, commissions, service tax (if any), etc. You may find some funds with similar objectives having different expense ratios. It depends on AUM and the actual costs incurred by fund house to run the scheme. The expense ratio also varies depending on whether equity fund is managed actively or passively. Actively managed funds have larger expense ratio than passively managed funds.

How is equity funds taxed?

In equity-oriented mutual funds, the investors get profits in the form of capital gains and dividends. Capital gains are termed as the difference between purchase price and selling price of mutual fund units. Profits earned from sale of equity mutual funds, which are less than a year, are termed as short-term capital gains and taxed at 15%. The profits on investments held for more than a year is termed as long-term capital gains and taxed at 10% (if the long-term gains exceed more than Rs. 1 lakh). The dividend is amount distributed to unit holders as a part of the returns made by the funds. Investors are not liable to pay tax on dividends earned. However, before paying dividends to the investors, the fund house incurs a dividend distribution tax. A Securities Transaction Tax (STT) is applicable to equity-oriented mutual funds at a rate of 0.001%. A STT paid at the time of redemption and deducted from the mutual fund returns.

Who is best suited to invest in equity mutual funds?

Anyone aiming for capital appreciation can invest in equity mutual funds. Your decision to invest in equity funds must be in line with your investment objectives and risk profile. These funds are best suited to invest for long-term goals of five years or more. The funds get sufficient time required to combat market fluctuations.

   

• An investor who has high-risk appetite

   

• Investors who can remain invested for long time 5-7 years.

   

• Investors who will not withdraw the funds very frequently

   

• Should be investing for long-term for wealth building & achieving financial goals

Classification of equity mutual funds

Equity mutual funds are differentiated based on:

Market Capitalization:

• Large-cap equity funds: These mutual fund schemes invest in companies that fall under the top 100 companies in terms of total market capitalization. These funds are suitable for investors who are interested in the investment of lump-sum amount and who have lower-risk appetite. Such funds have moderate growth potential with moderate returns. The liquidity of shares of large-cap funds is very high. These funds are mostly tapped by the institutional investors.

• Mid-cap equity funds: These mutual fund schemes invest in companies that fall under 100-250 companies in terms of total market capitalization. Compared to large-cap funds, these funds have better growth potential and offer higher returns on investment, suitable for investors bearing moderate risk levels. Midcap funds are largely targeted by institutional investors.

• Small-Cap Equity Funds: These mutual fund schemes invest in companies having a market cap of less than INR 5000 crores. These stocks are ideal for the investors having a high-risk appetite, who intend to earn high returns. These funds have exponential growth potential but long periods of small movements.

• Mid-and-small-cap funds: These funds invest in stocks of companies that fall under mid-cap and small-cap funds and have the potential to offer high returns.

• Multi-cap funds: These funds invest in stocks across all market capitalizations. At least 65 percent of assets invested across the large-cap, mid-cap, and small-cap stocks and other 35% in equity-related instruments. An investor gets the benefit of a diversified portfolio that helps in reduction of risk. If you intend for higher returns, multi-cap funds are a good option. Diversification reduces the investment risk level.

Investment Strategy:

The strategy based types of funds.

• Sectorial equity funds: These funds focus on a specific sector and pick the stocks of companies of a particular sector - like pharmaceuticals, banking, technology, etc. These are riskier funds and highly volatile due to holdings in one particular sector.

• Thematic equity funds: These funds show interest in stocks of companies around a particular theme like stocks in infrastructure or companies related to housing, consumption or travel etc.

• Value strategy: These equity mutual fund schemes select stocks of companies that are under performing at present and expected to make an impressive rise in the future. The stocks are bought at a very low price and when the market rises - are sold off or held depending on the investment objective.

• Growth strategy: These funds invest in companies that are already performing well, scheduled, and expected to grow and perform better in the future as well.

• Bottom-Up strategy: After deep research on various companies, fund manager selects the stocks and shares to invest in, based on the company’s profitability and potential for growth irrespective of which economic sector or theme they belong to.

• Top-Down strategy: Under these funds, the sectors are chosen first and then the best stocks in it are focused.

Tax Benefit:

Well recognized as a tax-saving scheme, Equity Linked Savings Scheme (ELSS) is another type of equity mutual fund scheme that has a lock-in period of 3 years. Investors get deduction in taxable profit calculation up to Rs.1, 50,000. It is mandatory for the fund to invest at least 60% of assets allocated into equities.

Ways to invest in equity mutual funds

• Through the lump sum approach,you can pay the entire amount in one time

• By investing small amounts at regular intervals through SIP approach for a predetermined tenure.

How can we calculate maturity value of equity mutual funds?

The NAV of mutual fund schemes keeps altering based on the performance of its invested assets. NAV is nothing but price of unit of a given mutual fund. To calculate the potential value of your investment on its maturity date, use our SIP investment calculator. Ex : If you hold 1000 units of a scheme where the present day NAV is Rs.47 then value of your investment is Rs 47000 ( 1000 Units X Rs 47 NAV )

Things to consider before investing in equity mutual funds

It is essential to keep in mind a list of a few things before arriving at an investment-making decision in equity mutual funds.

• Decide your financial goal

Draw a target/goal for which you want to invest. Next, evaluate and select the best investment option that is in line with your financial goal. Also, decide the tenure for how long you plan to make investments.

*Equity mutual funds benefit largely in long-term investment goals.

• Performance of Funds

Consider a few factors like fund rating, past performance of fund manager, historical returns, reputation of fund house etc. to draw an overall performance of the fund.

*Equity mutual funds are known to deliver highest returns.

• Risks Involved

Equity mutual funds are riskier compared to other fund types. The risk appetite of the investor defines the investment type, wheather it should be a long term or a short-term. The diversified Equity mutual funds reduce the risk level as the total corpus gets invested into a different Stocks or companies.

• Lock-in Period

ELSS & some close ended equity funds have a lock-in period of 3 years. Thus, it is not advisable for investors who are looking for short-term investment options.

• Asset Management Company (AMC) and Fund Managers

The role of a fund manager is to plan the investment strategy and accordingly allocate funds. AMC’s hire fund managers who are experts in analyzing companies and stock markets, look for reputation of the AMCs.

• Costs Involved

As investors, you should be aware of expenses related to purchasing and redeeming mutual funds such as expense ratio, entry load, and exit load. It is also imperative for an investor to review and compare these costs with other fund houses.

• Other Portfolio factors

NAV, AUM, funds ratings, etc. are also essential terms, which need attention before deciding the investment strategy.

How to deal with Equity funds during this global recession?

Because of the present coronavirus pandemic, the stock market is witnessing a massive fall. From the present scenario, it seems the market might take longer to recover. The present crisis has turned into almost a global recession and this is leaving an adverse impact on the investors. While the volatility seems to continue in the near future due to lockdown and pandemic, the investors should not rush for redemption. Most of the investor’s portfolio is equipped with a large portion of equity funds. Seeing the stock graph sloping down, the equity fund holders are worried. Let us discuss a few possible ways to handle the portfolio during the market downturn.

 •  What is better to opt for in the worst situation like a global recession? One must not stay away from equity when the market crashes and economy slows down. You can consider equipping your portfolio with funds and stocks that pay dividends, focus more towards large-cap stocks, invest in utilities, consumer staple stocks, or gold.

 •  Diversify your portfolio with hybrid funds. Hybrid fund is meant to mitigate risk and losses. In hybrid funds, equity funds share a major portion of the portfolio. Nearly 60-65% is equity fund and the rest 35-40% is debt funds. Your funds will have less variation in returns.

 •   In case, your decided time horizon is 5 years and you have already crossed 2-3 years then you may exit to avoid any further erosion in your portfolio value. Evaluating the present market position and considering the history of market recovery, it might take more than a year for a present bear market to turn into a bull market. In this situation, it is prudent to redeem and avoid further losses. If money is not required in urgency, you can also extend the time horizon to 8-10 years, which can cover the present losses when the market recovers.

 •   In the present situation, you might be struggling with an idea to exit now and re-enter when the market touches its bottom. In other words, you are trying to time the market. As no one can exactly point out the bottom of the market, it is a futile exercise.

 •   You can take advantage of the present lower market. Continue your SIPs accumulating more units at lower prices and if feasible invest more through SIPs. This will average your cost when the market recovers.

 •   Park your money through STP/SIP. STP is an ideal way to deploy the amount gradually from debt funds to equity funds. Money sitting in the bank earns nearly 4-5% interest. You can deploy the same amount investing as a lump sum in debt funds, which fetches you nearly 7-8%, an interest that is higher than a bank’s interest rate. The amount is then gradually invested in equity funds from these debt funds through SIP instalments.

 •   When equity market hits massive falls, emergency fund is another option to meet such a global recession. Redeeming equity funds during recession could mean booking losses for you. At times, when we are in need of funds and left with no other option, emergency funds prove as financial safety to meet any misfortunes. You should have an amount in funds that can cover at least 6 months of expenses. During times like present recession and restricted earnings or no earnings, these funds are useful to meet expenses in daily life for short duration.

Conclusion

Capital appreciation is the main aim of any investment. Returns of equity funds have consistently beaten all the other asset classes and proved to be an ideal investment for long horizon. It is best suited for the people who are not well versed in stock market but want to benefit from it. Investing on monthly basis a small amount is the best method to reap the benefit of equity mutual fund. These funds are more suitable for those investors who can accept and live with the variation in equity mutual fund prices.

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