How Do Equity Mutual Funds Work?

Equity mutual funds are certainly a very important asset of the investing domain for generating superior returns. Investors who invest in equity mutual funds and take advantage of its high return potential should also know about the working of equity mutual funds.

Equity mutual funds work by investing the majority of investors funds in equities (stocks) of various companies. Stocks have a great potential to generate superior returns on your investment and generate alpha. They are highly reactive to the market volatility due to which it makes it possible for them to generate such impressive returns.

If an investor buys a stock it simply means that he is a proportionate owner of the corporate and its business profits and losses.

Hence, if you are heavily invested in one stock and if its valuation falls down then chances are you may incur huge losses.

Diversification with Equity Mutual Funds

  • Mutual funds offer optimum diversification by pooling in investor’s money and spreading it across stocks of various companies.
  • This reduces your exposure to risk by not exposing all your investments in one particular stock only.
  • Moreover, this diversification and fund or stock selection is done by expert fund managers.
  • These fund managers are expert in this field due to their immense knowledge in this sector and prominent years of experience.
  • In equity mutual funds, a minimum of 65% of investors investible corpus is invested in equities (stocks).
  • This is spread across various stocks of companies and the rest is invested in other asset classes.
  • These asset classes provide their benefits as well that may get in line with the advantages of equity mutual funds.

Power of Compounding

"My wealth has come from a combination of living in America, some lucky genes, and compound interest"

-Warren Buffett

Compound interest is a long term investment strategy. It re-invests your profits and you earn interest on it. Equity mutual funds carry this essence of wealth compounding

Tax Benefits

  • Some equity funds, under the Section 80C of Income Tax (IT) Act, 1961 provide tax benefit of about ₹ 46,800/- on investing ₹ 1,50,000/-.
  • This type of equity fund is called (ELSS) Equity Linked Savings Scheme funds.
  • Other equity funds are taxed based on the investment horizon.
  • For investors, invested in the long-term in equity funds and choose to withdraw from it are then liable to pay tax of 10% on returns of ₹ 1 lakh.
  • Investors invested in the short term are liable to pay tax of 15%.

The long term tax is liable for investment horizon of more than a year whereas short term tax is liable for investment horizon of less than a year.

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Where does the majority of equity mutual funds investments go?
Majority of equity funds investment goes in stocks. Stocks represent holdings of company’s assets and represents proportionate ownership of company and its business profits and losses.
Who are fund managers?
Fund managers are experts who have an immense knowledge in the finance domain and manage investor’s money and the scheme’s portfolio.
What is the power of compounding?
Power of compounding or compound interest is a long term investment strategy. It re-invests your profits and you earn interest on it. Equity mutual funds carry this essence of wealth compounding.