Equity mutual funds are mutual fund schemes that invest over 65% of their capital in equity and equity-related securities. In simple words, equity funds invest in a diversified basket of company stocks. Investors are drawn to equity funds due to their high return potential. However, these funds are also prone to significant risks and can be highly volatile. So, if you wish to maximise returns with equity investments, you need to first understand how to choose funds carefully. This article outlines the things you must consider before investing in equity funds to make an informed choice.

If you wish to invest in equity funds for long-term wealth-creation, here’s a list of things you should first consider:
 

Fund size

The total assets under management or AUM represent the size of an equity fund. In simple terms, AUM is the total market value of the assets being managed by the fund. The fund manager handles the AUM to generate returns for investors. It is commonly believed that a fund’s performance may be affected if its size becomes too big or small. However, there are no official guidelines as to the ideal size of a mutual fund scheme. Some investors believe that a larger fund is better, but others contend that the fund’s performance may decline if it grows too big. One way of solving the maze is comparing mutual fund schemes with varying AUMs against the category average.
 

Expense ratio

Another important thing to consider before investing in equity funds is the expense ratio of the fund. Expense ratio is the annual fund management costs you have to pay to the AMC. Since it is an investment cost, high expense ratios can lower your net returns. Generally, the expense ratio of actively managed funds tends to be higher than passively managed ones. So, if you’re looking for lower investment costs, consider comparing expense ratios of short-listed equity funds before adding them to your portfolio.
 

Risk-reward ratio

The risk-reward ratio or RRR is a measure of the prospective return an investor can make for every rupee invested and risked in the market. Essentially, RRR helps investors compare the risk and return profiles of different investments. Comparing the risk-reward ratio helps investors understand if the returns from the equity fund are worth the risk. Therefore, you should add RRR as one of the few things you need to consider before investing in equity funds. The RRR of the fund should coincide with your risk-return profile.
 

Type of equity fund

There are different kinds of equity funds available in the market to suit varied investor requirements. Equity funds can be classified in different ways as well. Market capitalisation is the most common way of classifying equity funds. Large-cap funds invest in stocks of the top 100 companies with a market cap of Rs. 20,000 Crore or more. Mid-cap funds invest in companies with a market-cap of Rs. 5,000 Crore to Rs. 20,000 Crore, while small-cap invest in emerging companies with a market cap of less than Rs. 5,000 Crore. Large-cap funds provide greater stability and lower risk, while small-caps offer higher return potential but come with increased volatility.
 

Similarly, equity funds can be categorised on the basis of where and how they invest. For instance, sector equity funds concentrate their investment in specific market sectors like pharma, IT, or BFSI. Thematic equity funds follow a specific theme or pattern for selecting stocks. Focused equity funds are another common equity fund variant that invest in only a fixed number of stocks. As per SEBI, focused equity funds can invest in up to 30 stocks from different market caps. On the basis of investment style, equity funds can be classed as value funds and contra funds. The former invests in undervalued stocks, while the latter goes against the prevalent trend to invest in stocks that are not presently performing well. The risk-return profile of funds will vary depending how how they invest. Therefore, you must consider these things before investing in equity funds.
 

Tax implications

Taxation is another important thing you must consider before investing in equity funds. If you’re looking for 80C tax deductions, you must invest in equity-linked savings scheme (ELSS) funds. You can claim an annual tax deduction of up to Rs. 1.5 Lakhs u/s 80C of the Income Tax Act, 1961 for ELSS investments. However, these funds also come with a mandatory 3-year lock-in window.
 

Considering capital gains taxes is equally crucial to understand your real returns from the investment. Equity funds are subject to the following capital gains taxes:
 

• LTCG: A long-term capital gains tax of 12.5% is applicable on the gains from the sale of equity funds held for more than a year. No LTCG is applicable on annual gains of up to Rs. 1.25 Lakhs.
• STCG: A short-term capital gains tax of 20% is applicable on gains made from the sale of equity funds held for less than a year.
   

Dividends

Earlier, India levied a dividend distribution tax (DDT) on equity dividend payouts. However, DDT was abolished in 2020. Section 194K was introduced which stated that a 10% TDS will be applicable on dividend payments in excess of Rs. 5,000. If the dividend payment is less than Rs. 5,000, no TDS is applicable. Since it is collected as a tax at-source, the fund manager deducts the applicable TDS before remitting the dividend amount. This TDS can be adjusted against your tax liability on dividend income while filing your annual ITR.
 

Fund performance

One thing you must consider when investing in equity funds is the fund’s past performance. This means reviewing the fund’s track record over the last 5-6 years and comparing the same against the fund’s benchmark. You can also compare mutual funds’s returns against peer funds in the same equity fund category. Remember to look for funds that have consistently outperformed the benchmark over a relatively long duration.

Investing in mutual funds is easy and safe if you know what to look for. This guide outlined a few things you can consider when investing in equity funds to make an informed choice. Reviewing past performance, expense ratio, fund size, RRR, and tax implications can make a significant difference to your bottom line in the long-run. Apart from these factors, you must ensure that the equity fund aligns with your financial goals. Every investor has unique goals, time horizon, and risk tolerance. Therefore, it is important to match the same against equity funds to see which fund best meets your requirements.
 

Ready to invest in the best equity funds? Head to the Bajaj Finserv Mutual Fund Platform where you can pick from 1000+ schemes. From comparing funds and their past performance to starting SIPs for as little as Rs. 100, you can do it all with a few easy clicks. Additionally, you can use the Mutual Fund Calculator tool available on the platform to compute your returns and plan ahead.

• Consider the size and performance of the equity fund before investing.
• Expense ratio of the fund can impact your net returns, while the risk-reward ratio can help you find funds within your risk profile.
• Capital gains from equity funds are taxable at different rates depending on the holding period of the fund.
• Only ELSS funds offer 80C tax deductions.