What are equity mutual funds?

Learn if these funds can be a sound wealth-building option for new investors like you

What are equity mutual funds?

Sometimes, words used in the investing world seem heavier and more complicated, than they actually are.

That's the case with equity mutual funds too.

An equity mutual fund is basically a type of mutual fund that invests in company stocks. These company stocks are listed on the stock market (Bombay Stock Exchange, National Stock Exchange).

For those who want to be technically correct, equity mutual funds invest at least 65 per cent of their investment in stocks and the remaining can be in the slightly-safer debt or money market securities.

Why do people invest in equity mutual funds?
Let's start with why people invest in company stocks (equities). This question is important because you might have heard that stocks are risky investments. It's true. They are risky, but usually over a short period of time.

However, from a long-term perspective, stocks have been known to generate high returns. In fact, in the last 20 years, Sensex - the best-known stock index in India - has delivered more than 15 per cent returns each year, which is higher than real estate, gold and fixed deposits (FDs).

But that doesn't mean a new investor should start investing in stocks directly. That's because direct stock investing requires one to identify a promising company, do intensive research and decide when to enter and exit the stock. Now, that sounds too much work for a beginner or for someone who doesn't have time.

This is where equity mutual funds step in. These funds are a hassle-free and relatively risk-free option for investing in stocks. Here's why:

  • Professional research
    While equity is undoubtedly a wealth creator, a poor stock selection can be a wealth destroyer. But you can avoid such a situation by opting to invest in equity mutual funds. Here, professional fund managers do the job for you. They make decisions after putting in hours of manpower in research and analysis.
  • Option to start small
    You need a fairly large amount if you want to buy stocks directly and build a portfolio. But that's not the case with equity mutual funds. It is possible to start with as little as Rs 500-1,000. This amount is all you need to get a portfolio of 25-30 stocks or more.
  • Benefit of diversification
    Since equity funds allow you to buy a collection of 25-30 stocks or more, you are reducing the element of risk. This is known as diversification. On the other hand, if you invested in one company stock, your fortunes would depend on that particular stock only. That could be a risky strategy.
  • Disciplined and regular investing
    Many investors tend to lose their nerve with the sharp ups and downs in the equity market. As a result, they often end up buying stocks at a high price and selling at a low, which is the opposite of what they should be doing. Further, many people often lack the discipline to invest regularly and end up blowing their money on unnecessary expenditures. This can cause a serious dent on the amount of wealth you can generate.
    Mutual funds solve both these problems with the 'systematic investment plan', popularly called an SIP. It is an investment method wherein you can put a fixed amount in a mutual fund at regular intervals - say monthly. So a fixed sum of money is debited from your bank account every month on the specified date of your choice and gets invested in the fund.

Therefore, equity mutual funds keep it very simple for you. They not only do the decision-making for you but also make you a long-term investor, which is the secret mantra of getting wealthy.

Thus, compared to directly picking stocks, mutual funds are a more suitable route for a lot of people, especially if you are a new equity investor.

Suggested read: How to choose an equity fund?

New to investing? Check out our specially curated page for beginners.

Visit Get Started

Other Categories