ETMutualFunds recently started a series on mutual funds for the benefit of new investors. We started off with the misconceptions new investors have about mutual funds. Read the story: Why do some new investors hesitate to invest in mutual funds?
Then we introduced them to the benefits of investing in mutual funds.
Read: Five reasons why you should invest in mutual funds. It is time to understand the investment options available. Here we will focus on equity mutual funds and how to use them smartly and create wealth over a long period.What are equity funds ?
Equity mutual funds invest mostly in equity or stocks. According to Sebi, the mutual fund regulator, these schemes should invest at least 65% in stocks. They are further divided into ten categories, based on their investment universe and investment strategy, and investment style, and so on.
Equity mutual fund categories
- Multi cap funds: According to Sebi, these funds must invest at least 25% each in large cap, mid cap and small cap stocks. Since they invest in mid cap and small cap stocks, they have very high risk. If you have a high risk appetite and long investment horizon, you may invest in them.
- Large cap funds: These funds invest in top 100 stocks by market capitalisation. These companies are leaders in their respective areas, and they are more resilient to economic shocks. That is why these schemes are recommended to ‘conservative’ equity investors
- Large & mid cap funds: Sebi mandates these funds to invest at least 35% each in large and mid cap stocks. Investing in mid caps can be risky. So, invest in these schemes only if you have a very high risk appetite.
- Mid cap funds: These schemes must invest 65% in mid cap stocks. If you have a high risk tolerance and intend to invest for a long term, you may invest in these schemes.
- Small cap funds: These funds invest in the stocks of companies from the 251th position onwards in terms of market capitalisation.These companies are relatively smaller in size and they can be hit badly in adverse market conditions. Therefore, these funds are only recommended to aggressive investors, who have a high risk appetite and long investment horizon.
- Dividend yield funds: These funds predominantly invest in stocks that offer higher dividend yields. They should invest at least 65% in equities. These funds are suitable for investors who don’t want to face a lot of volatility.
- Value funds :These funds follow a value investment strategy to pick stocks. They invest stocks that are undervalued and wait for the market to realize the true potential of the stocks to make money. These schemes are recommended to sophisticated investors who subscribe to value investing principles and with a lot of patience.
- Contra funds : These schemes follow a contrarian investment strategy. The fund manager bet against the prevailing market trends. When the trend turns around, s/he makes money. Only recommended to investors who want to go against the prevailing market wisdom.
- Focused funds: These schemes are mandated to invest in a maximum of 30 stocks. These schemes are ideal for investors who want to bet on a concentrated portfolio. If you have a high risk tolerance and long investment horizon, you may invest in these schemes.
- Sectoral / Thematic funds : These schemes invest in a particular sector or scheme. For example: infrastructure, ESG, pharmaceutical etc. They are meant for very rich and sophisticated investors to diversify their portfolio. We don’t recommend these schemes to new and inexperienced investors as they are highly risky and go through phases.
- ELSS: Investments in these schemes qualify for tax deductions of up to Rs 1.5 lakh in a financial year under Section 80C. They have a mandatory lock-in period of three years. Recommended to taxpayers looking to save taxes under Section 80C.
- Flexi cap schemes: These schemes are recommended to moderate investors to create wealth over a long period of time. They have the freedom to invest across market capitalisations and sectors/themes based on the outlook of the fund manager.
