What Is an Equity Fund? A Complete Guide to Equity Mutual Funds in India

Equity funds are your gateway to wealth creation through the stock market. If a mutual fund invests 60% or more of its assets in shares of listed companies, it qualifies as an equity fund. The remaining portion is usually parked in debt instruments for stability. Often called growth funds, these are designed for long-term capital appreciation. With an average return potential of 10% to 12% before taxes, equity funds have historically outperformed most traditional investment options, making them a preferred choice for investors seeking higher returns over time.

Structure of Equity Funds

Equity funds are structured as pooled investment vehicles where money from multiple investors is collected and managed by professional fund managers. These funds primarily invest in stocks of publicly listed companies across sectors and market capitalisations – large cap, mid cap, or small cap. A portion of the fund may be allocated to debt or cash equivalents for liquidity and risk management. Equity funds can follow different strategies like value investing, growth investing, or a blend of both. The fund’s structure ensures diversification, reducing company-specific risks while aiming for long-term capital appreciation.

Types Of Equity Fund

The categorisation of equity funds depends on several factors. These include the fund house’s investment approach, the market capitalisation of the company, or what a particular fund invests in.

• Active and passive funds:

These categories refer to the investment approach. A fund manager may follow their own investment strategy. They may do this after studying the market performance and the company’s background. This is an active fund. When your investment portfolio reflects a market index like Sensex, it is a passive fund. Such funds that follow one index are also termed as index funds.

Active and passive funds serve different purposes. Active funds aim to beat the market, while passive funds aim to match it. If you are looking for potentially higher returns and are comfortable with some level of risk, active funds may suit you. On the other hand, passive funds often come with lower fees and can be ideal for long-term, cost-conscious investors.

• Large-cap, mid-cap, small-cap, and micro-cap funds:

This refers to market capitalisation. Market capitalisation is the value the capital market places on a company’s equities. So, large-cap equities are usually of well-established companies. Such funds tend to be stable. Mid-cap and small-cap funds invest in smaller companies. But such companies may not have found a stable footing. So, the returns may be irregular. Some equity funds invest across large-cap, mid-cap, and small-cap stocks. These are called multi-cap funds.

Multi-cap funds offer the advantage of diversification across different market segments. While large-cap stocks provide stability, mid- and small-cap stocks add growth potential. This mix allows fund managers to balance risk and return dynamically based on market conditions, making multi-cap funds a flexible option for investors seeking both growth and risk mitigation.

• Diversified and sectoral funds

This refers to the type of companies or industries a fund chooses to invest in. Diversified equity funds spread their investments across companies from various sectors and industries, such as banking, healthcare, IT, and consumer goods. This broad exposure helps reduce the risk associated with any single industry downturn, making diversified funds more stable over the long term. In contrast, sectoral funds concentrate their investments in a single sector, such as pharmaceuticals or infrastructure. While they can offer high returns when that sector performs well, they also carry higher risk due to limited diversification.

• Thematic Funds

Thematic funds invest in companies that align with a specific investment theme, rather than sticking to a single sector. For example, a fund may focus on emerging technologies, rural consumption, or ESG (Environmental, Social, and Governance) principles. These funds can include companies from multiple sectors if they fit the central theme. While thematic funds offer the potential for high returns when the chosen theme performs well, they also carry higher risk due to limited diversification and dependence on a specific macro trend.

• ELSS

Equity Linked Savings Scheme (ELSS) is a type of equity mutual fund that offers tax benefits under Section 80C of the Income Tax Act. You can claim a deduction of up to ₹1.5 lakh annually by investing in ELSS. These funds have a mandatory lock-in period of three years, the shortest among tax-saving instruments. ELSS funds primarily invest in equities and have the potential for high returns over the long term. However, like all equity investments, they carry market-related risks.

How to Invest in Equity Funds?

• Start by clearly defining your financial goals, risk appetite, and investment horizon as these guide your fund selection process.
• Next, choose a fund aligned with your profile such as large‑cap for stability, mid‑/small‑cap for growth, or ELSS for tax savings. Compare performance, expense ratios, and fund manager credentials using tools and fund fact sheets available from AMFI or fund platforms.
• Once selected, complete your KYC (Know Your Customer) documentation. You can invest via two routes: o Lump-sum investment for one-time investments. o Systematic Investment Plan (SIP) for regular, disciplined investing.
• Invest through mutual fund websites, broker platforms, or aggregators. Your order is executed at the end-of-day NAV. Regularly track the fund via monthly fact sheets and reassess periodically.

How to Pick the Right Equity Fund

There are multiple factors that you should consider before making a choice. Weigh your options and think about your priorities. Every person has a unique set of circumstances. So, a strategy that may fit one person may not be the best one for another.

• Investment horizon:

Equity funds are usually long-term investments. You should stay invested for five years. If you cannot keep your money parked for that long, then equity funds may not be ideal for you. In the short term, you may not get the best returns.

• Tax benefits:

The government encourages people to invest in equity by providing tax benefits. If you invest in equity-linked saving schemes (ELSS), you get tax benefits under Section 80C. In fact, such schemes have a shorter lock-in period of three years. They offer higher returns as well.

• Risk appetite:

If you want to put your money in established companies, large-cap funds are best for you. They invest in the top 100 companies. This is suitable if you have ventured into the stock market just recently. These are less volatile, but you need to stay invested for a long time to get assured returns. If you can afford to take a calculated risk, go for diversified funds. They invest in a combination of large-, small-, and mid-cap funds. They are a good option if you are looking for high returns with less risk.

• Past Performance:

Reviewing a fund’s past performance helps you understand how it has managed different market conditions. Look at 3-year, 5-year, and 10-year returns instead of short-term gains. Compare the fund’s returns with its benchmark and category average. However, past performance does not guarantee future results. A consistently performing fund indicates good fund management and strategy. Also, check how the fund performed during market downturns. This gives insights into risk management. Avoid funds with erratic returns or those that underperform their peers over time.

• Expense Ratios:

Expense ratio is the annual fee charged by a fund house to manage your investment. It is expressed as a percentage of your total investment and directly affects your net returns. Lower expense ratios are generally better, especially for long-term investors, as inflated costs can eat into profits. Actively managed funds usually have higher expense ratios than passive or index funds. Always compare the expense ratios of similar funds before investing. Even a 1% difference can have a significant impact over time, especially for large investments.

What Are the Advantages of Equity Funds?

It is not just about high returns. In fact, many other factors contribute to make equity funds an attractive choice.

• Professional expertise:

With equity funds, you make the most of a fund manager’s expertise. They do the research and market analysis on your behalf. It saves you trouble. It also prevents you from taking any ill-informed decision.

• Diversification:

You get to invest in a range of companies. Your investment gets distributed across many sectors. So, in a way, this moderates your exposure to risk.

• Liquidity:

You can withdraw your money any time you wish to. The only exception is an ELSS, where the lock-in period is three years.

• Systematic investment:

You can opt for a systematic investment plan (SIP). This way, you put in a moderate amount of money at fixed intervals. This helps you build a habit of investing regularly.

• Tax benefits:

With ELSS, you get benefits under Section 80C. With other kinds of equity funds, the rate of tax depends on your investment period. If you stay invested for less than one year, you need to pay short-term capital gains. If you stay invested for a longer period, you are liable to pay long-term capital gains tax.

Tax Treatment of Equity Funds

• Short-Term Capital Gains (STCG): Gains on units sold within 12 months are taxed at 20%.
  
• Long-Term Capital Gains (LTCG): Gains on units held more than 12 months, in excess of ₹1.25 lakh in a financial year, are taxed at 12.5%.
  
• Indexation benefits have been removed for equity funds – your gains are calculated on the actual difference, without inflation adjustment.
  
• STT (Securities Transaction Tax) remains applicable at the time of sale.
  

Who Should Invest in Equity Funds?

Equity funds are best suited for long-term growth investors who can tolerate short-term volatility.

• Long-term goals (5+ years) like retirement, buying a home, or wealth building align with the higher potential returns of equity funds.
  
• Moderate to high risk tolerance is essential. Equity funds can swing significantly in the short run but historically outperform other asset classes over time.
  
• Younger investors or those with steady income and a long horizon can benefit the most from disciplined investment via SIPs, which mitigate market-timing risk.
  
• Tax-savers, particularly under the old tax regime, could historically benefit from ELSS funds—but with the growing adoption of the new tax regime, ELSS is losing ground due to removed Section 80C deductions.
  
• Conservative investors or those with shorter horizons (under 3–5 years) should consider balanced or hybrid funds, or theoretically switch to debt instruments, since sudden equity downturns can impact returns.
  

Equity funds remain a powerful tool for long-term wealth creation, provided you are aligned with your risk and horizon profile.

Conclusion

For those venturing into the stock market, equity funds are a great choice. You get to invest across sectors under professional guidance and regulate your risk exposure. You also get tax benefits and higher returns. On an average, equity funds give a return of 10% to 12% in India. Before you start investing in mutual funds, there are a few more important points to keep in mind like taxation. This can affect your total financial returns. To know about these factors, click here.

Read more:

How To Invest In ELSS?
What are Thematic Mutual Funds and How Do They Work?