Equity Mutual Funds: A Simple Guide

An equity mutual fund pools money from many investors and uses it to buy shares of companies. Under SEBI rules, equity funds must hold a large share of their money in equity, with the exact minimum depending on the category.

Each investor owns units of the fund, and the value of each unit, the NAV, moves with the prices of the shares the fund holds. Our page on what a mutual fund is explains the basic structure.

Equity funds grow mainly when the companies they own become more valuable, as their profits rise over the years. Dividends paid by those companies also add to the fund value.

Over short periods, share prices are driven by news and mood. Over long periods, business growth has historically mattered more. Our page on how mutual funds make money explains this in plain words.

Large cap funds invest mainly in the biggest companies in the market, the top 100 by market value. These are well-established businesses, so large cap funds are usually the steadiest among equity funds.

They still fall in market crashes, but generally less than mid and small cap funds.

Mid cap funds invest mainly in companies ranked 101 to 250, and small cap funds in companies beyond that. Smaller companies can grow faster but are also more fragile, so these funds swing much more.

Our page on large, mid and small cap funds compares them in detail.

Flexi cap funds can invest across companies of any size, in any mix the manager chooses. Multi cap funds must hold minimum amounts in large, mid and small caps.

Both offer broad diversification in one fund. Our page on flexi cap versus multi cap explains the difference.

ELSS funds are equity funds with a three-year lock-in, and investments in them may qualify for a tax deduction under certain tax rules. They invest across company sizes like a flexi cap fund.

Our pages on ELSS funds and ELSS versus flexi cap explain them further.

Index funds simply copy a market index, such as the Nifty 50, at low cost. They do not try to beat the market; they aim to match it.

Many investors use them as a simple core holding. Our page on index funds explains how they work.

These funds invest in one sector, like banking or technology, or one theme, like consumption or manufacturing. They are much less diversified and can lag for long periods.

Our page on sectoral and thematic funds explains why they should be a small part of a portfolio, if used at all.

Equity funds can fall sharply in a market decline. In severe crises of the past, broad equity funds dropped by large amounts before recovering over time. That is normal, not a sign that something is broken.

The risk of a permanent loss is much lower for a diversified fund held for many years than for a few shares bought directly. Our page on risk and volatility explains how to think about this.

Equity funds suit goals at least five years away, and seven years or more for mid and small cap funds. Money needed within three years should not be in equity funds, because a fall close to the date could leave you short.

Our page on short-term investment options explains better choices for near goals.

A SIP invests a fixed amount every month, spreading your entry across many market levels. This suits salaried people and reduces the worry of investing at a bad moment.

For large lump sums, spreading the amount through an STP can reduce timing risk. Our pages on SIP versus lump sum and STP explain both.

Start with the category that suits your goal and comfort with swings. Then compare funds within that category on long-term performance against the benchmark, consistency, costs and the fund approach.

Our page on how to choose a mutual fund lists the checks in order.

For most investors, two or three equity funds across different categories are enough. Holding many similar funds often means overlap and extra work without extra benefit.

Our page on diversification explains how much is enough.

Gains on equity funds are taxed when you sell, and the treatment depends on how long you held the units. We do not quote tax rates, as they change. A tax adviser can confirm your position.

Our page on mutual fund taxation explains the general structure.

• Stopping SIPs when markets fall.
• Choosing funds only by last year return.
• Using equity funds for money needed soon.
• Holding too many overlapping funds.
• Putting a large share into sector funds.

Our page on common mutual fund mistakes lists more.

Active equity funds have a manager who picks stocks, trying to beat the benchmark. Passive funds, like index funds, simply track an index at lower cost. Both have a place.

Many investors use a passive fund as a low-cost core and an active fund alongside it. Our page on active versus passive funds compares them.

• Equity funds invest in company shares.
• They suit long-term goals.
• Short-term falls are normal.
• Choose by category first, then compare funds.

We are distributors rather than investment advisers and we recommend no schemes. If you want help choosing equity funds for your goals, get in touch.