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Who Should Invest in Best Equity Funds?

You should consider your risk appetite and investment horizon while investing in equity funds. These funds are suitable for an investor having an investment horizon of five years or more. Hence, short-term investors should refrain from investing in equity mutual funds. If saving taxes is on your mind, then you can invest in ELSS , it is regarded as the best option under Section 80C of the Income Tax Act, 1961 .

ELSS has the shortest lock-in period of three years. Moreover, it offers a much higher return than other investments covered under Section 80C. A budding mutual fund investor may choose to invest in large-cap equity funds as these funds invest in equity shares of well-established companies that have a track record of offering stable returns in the long run. Conversely, an experienced investor, may choose to invest in diversified equity funds to balance the risk-reward ratio.

Taxability of Equity Funds

Dividends were earlier made tax-free in the hands of investors as the fund houses paid dividend distribution tax (DDT) before they paid investors with their share of dividends. As per the amendments made in the Budget 2020, the dividends offered by all mutual funds are now added to your overall income and taxed as per the income tax slab you fall under. This is referred to as the classical way of taxing dividends.

The rate of taxation of equity funds depends on the holding period. If you make short-term capital gains (realised on redemptions made within one year of holding period), they are taxable at the rate of 15%, irrespective of your income tax slab. Long-term capital gains (gains realised after a holding period of one year) of up to Rs 1 lakh a year are made tax-free. Any gains exceeding this limit are taxed at 10%, and there is no benefit of indexation provided.

Risks Possessed by Equity Funds

1. Volatility Risk

The market movements always influence equity mutual funds as they invest in equity and equity-linked securities. Volatility risk is the possibility of the fund’s NAV being affected by the market movements.

2. Concentration Risk

The concentration risk is the probability of the sector in which the fund is heavily invested underperforming. No doubt concentrating your investment towards a well-performing sector provides good returns during the bull-run. However, adverse developments will lead to magnified losses.

3. Liquidity Risk

Liquidity risk is the possibility of the fund manager not being able to sell the underlying securities without taking a significant risk.

Advantages of Equity Funds

1. Excellent long-term investment option

Equity funds are known to offer overwhelming returns on staying invested for at least five years. Therefore, these funds are an excellent long-term investment option.

2. Tax benefits

If you are to save taxes under Section 80C and grow your wealth over time, then you may consider investing in ELSS mutual funds. These funds are the best tax-saving investment option, and you get the dual benefit of tax deductions and wealth creation over time.

3. Benefit of diversification

Equity funds invest in equity and equity-linked securities of companies across sectors and market capitalisations. Therefore, investors get the benefit of diversification.

4. The potential to beat benchmark and inflation

Equity funds have the potential to provide inflation-beating returns. These funds also have the capability of offering benchmark-beating returns in the long run.

Things to Consider as an Investor

1. Fund Objectives

Best equity mutual funds aim at accumulating wealth through strategic investments. The stock picking is based on investing style, which can be value or growth investing. Value investing involves picking undervalued stocks whose price will rise, eventually leading to a profit.

2. Fund Types

Equity funds are further divided into purely large-cap, mid-cap, and small-cap funds. Small-cap and mid-cap funds come with a higher risk-return potential than large-cap mutual funds. Then there are multi-cap funds, which invest across stocks of all market capitalisations to maintain an optimally diversified portfolio.

3. Risk

Equity funds face market risk, which happens to be the most significant one. The equity funds are affected by the movements of an underlying benchmark such as Nifty or Sensex. The overall rise and fall in the index lead to the fluctuations in the value of equity funds. Such volatility is higher than that experienced by debt funds or money market funds.

4. Cost

Equity funds charge an expense ratio to manage your investment. SEBI has mandated the upper limit of expense ratio to be 1.05%. Actively-managed equity funds have a higher expense ratio as compared to index funds.

5. Investment Horizon

Equity funds are suitable for individuals who are having a long-term investment horizon. Usually, the fund experiences a lot of fluctuations during the short-run. This fluctuation averages out in the long-run of say, more than five years. The fund is, thus, able to give returns in the range of 10%-12%. Those who choose best equity mutual funds need to be prepared to stick around for at least for the said period to enable the fund to realise its full potential.

6. Financial Goals

Investing in equity mutual funds is ideal for achieving long-term financial goals, such as wealth creation or retirement planning. Being a high-risk and high return haven, these funds are capable of generating enough wealth, which may help you retire early and pursue your passion in life.

How to Evaluate Best Equity Mutual Funds?

1. Fund returns

Fund performance, in terms of return on investment, is considered the most crucial parameter for ranking or selection of funds. Investors may look at returns over a period say five years. One may select funds that have consistently outperformed their benchmark indices (index to which a fund’s returns are compared). They should also fare reasonably well when compared with their peer set over the more extended time frames.

2. Fund history

Active management from a trusted fund house is necessary before you invest in a fund. You must have confidence in the asset management company. Ideally, the chosen fund house should also have a clean and long business history of at least say, five years. It ensures that the fund has seen the market cycles of slump and rally numerous times.

3. Expense ratio

Expense ratio is the annual expense incurred by funds, and it is expressed in percentage of their average net asset. Expense ratio is what the mutual funds charge investors for managing money on their behalf.

4. Financial ratios

With the significant risks involved, the risk-return ratio becomes an essential factor for consideration. To judge this, the Sharpe Ratio is a critical metric associated with the equity fund’s performance. Sharpe Ratio is an indicator of risk-adjusted return. It represents the excess return provided by the fund for a given level of risk. In short, the higher the Sharpe ratio, the better is the risk-adjusted return for that fund.