Mutual Funds – Equity
Welcome to the next chapter of our introduction series on investment options.
Today, we take a look at Equity Mutual Funds.
Before we do so, here are our recommended brokers who can help you invest in mutual funds. We suggest you check each one and try at least 2 of them for a few months before you pick one platform for all your investments.
Why Equity Mutual Funds?
Mutual Fund is a concept where the money of various investors is pooled in and an asset management company then invests it in a portfolio of assets to generate returns. These investments can be varied and include Equity, Debt, Government Bonds, Gold, etc.
Let’s explore some of the features of an Equity Mutual Fund where the money is invested in equity or shares of companies.
Convenience
It is easy to invest through a mutual fund as you don’t need to understand the performance or outlook of different companies. The research is done by asset managers and your money is invested in a portfolio of stocks based on their expert analyses.
Tax Benefits
Investments in Equity Linked Savings Schemes (ELSS) are eligible for tax benefits and can be claimed as deduction under section 80C. Additionally, returns of mutual funds are taxed at lower rates compared to fixed deposits.
Higher Returns
Equity Mutual Funds offer higher returns. You can get an average range of 10-15% depending on your choice of funds while investments such as fixed deposits fetch 6-8%.
Dividend Income
The dividend declared by the invested companies is distributed to the mutual fund holders.
Suited for Everyone
People from all income backgrounds (one can start from as low as Rs. 500 per month) and risk profiles (mutual funds have multiple options) can invest in a mutual fund.
Diversification
It provides an additional investment avenue. You can also have money invested in Fixed Deposits, Insurance Plans, Retirement Funds, Real Estate or Gold, among others.
Investment Options: Lumpsum or SIP
There are two ways that you can start investing in a mutual fund:Lumpsum or SIP. Let us understand SIP first.
SIP or Systematic Investment Plan
This refers to investing an amount regularly. This frequency can be weekly, monthly or daily. A SIP offers the following advantages:
- Discipline: Easy to keep some money away every month
- Rupee Cost Averaging: There is no need to time the market. Whether it is moving up or down, the cost of investments averages out over the long-term
- Power of Compounding: Compound interest ensures better long-term benefits compared to one-time investment
Lumpsum Investments
If you have some surplus cash lying around, the same can be used to buy mutual fund units as a one-time investment. Unlike a SIP, here the benefits of Rupee Cost Averaging does not work out in your favour.
Types of Equity Mutual Funds
Equity Linked Saving Schemes (ELSS)
ELSS are equity-oriented schemes with a mandatory lock-in period of three years. They invest a majority of their corpus in equity or equity-related instruments.
They are a smart investment as you get tax exemption of up to Rs 1.5 lakhs on your taxable income under section 80C of Income Tax Act.
Large Cap Funds
In these funds, the majority of the corpus is invested in the largest companies in the market. These portfolio companies are the top 100 players in terms of market capitalisation.
The large cap mutual funds have lower growth potential and thus provide lower returns on investment when compared to mid and small cap funds. But they counter this with more stability of returns.
Mid Cap Funds
In these funds, the majority of investments is done in companies with market capitalisations that are less than that of the larger players. According to the Securities and Exchange Board of India (SEBI), mid-cap companies are ranked between 101 and 250 in terms of market capitalisation.
These funds offer better growth potential than large cap mutual funds and thus give investors higher returns on investment in comparison.
Small Cap Funds
In these funds, the majority of investments is done in companies with market capitalisations that are below the mid cap players. Since the mid cap players are ranked between 101 and 250 in terms of market capitalisation, all companies below the top 250 are usually called small cap firms.
Small cap funds offer better growth potential than large and mid cap mutual funds and thus give investors higher returns on investment in comparison. But they are also the most volatile of the three categories.
Multi Cap Funds
These funds invest in all large cap, medium cap and small cap companies. The asset managers of these funds are allowed to invest in lucrative companies without being too risky.
Most of these funds have different focus in terms of investment. Some focus primarily on large cap while others may focus on mid cap or small cap companies.
Hybrid Funds
These funds have a mix of investment. For instance, it may be a mix of equities and debt investments. The proportion of each asset class depends on the investment objective of the fund.
There are different types of these funds such as Equity-oriented Hybrid Funds, Debt-oriented Hybrid Funds, Balanced Funds, Monthly Income Plans and Arbitrage Funds.
Expenses
The fund management is not doing these investments for you for free. They charge some fees to pay or all the work they are doing for you.
- Annual Fee: This is charged at 2.25% per annum and pays for the expenses of the fund manager
- Entry & Exit Load: This is charged around 2.5%, though the final rate varies with each fund
Types of Plans: Direct or Regular
Every Mutual Fund scheme has two categories of plans: Direct or Regular based on how these investments are made.
A Direct plan is what you buy directly from the mutual fund company, usually from their own website. Whereas a Regular plan is what you buy through an advisor, broker, or a distributor (also called an intermediary). In a regular plan, the mutual fund company pays a commission to the intermediary which in turn is deducted from you.
To lessen the annual expense being charged by the mutual fund house, you can go for Direct Funds. You save up to 1% in commissions every year. The impact of these savings compounds in the long-run.
How to Invest
If you don’t have time or don’t want to put any efforts in managing your funds, then go for an advisor based regular fund.
You can look for platforms which are consolidating all fund houses or you can invest through your local financial advisor. All large banks sell mutual fund products
However, if you want to take control of your investments then look for direct fund options. There are different fund websites that allow you to invest directly. Make sure you check the ratings and performances of the funds before you invest. There are various websites available online for comparison.
Just remember that Mutual Funds are long-term investments only. So tie-up your goals with the investments you are making. E.g. you can save for a Vacation, House, Car, Marriage, Education, etc.
Opt for a SIP if possible as it averages out the risks and helps you become more disciplined as well.
Summary
Equity Mutual Funds are a good option if you want to increase your returns compared to other investments such as fixed deposits or insurance plans and you don’t have time to monitor your investments on a regular basis. Its true value is realised when you invest for the long-term as it ensures all up and down cycles get factored in.