Understand how equity mutual funds work

Mutual funds are gaining popularity in India as a viable investment option. You might be curious about the fundamentals of mutual funds and would want to learn something about what mutual funds are? How do mutual funds operate?

Mutual funds that invest largely in stocks are known as equity funds. You could invest money into the fund either as a lumpsum amount or small amounts through a SIP. And the fund invests your money in various equity stocks on your behalf. The profits or losses in the portfolio impact the Net Asset Value of your fund (NAV). Of course, there are some complexities to consider, but this is the heart of equity mutual fund investments.

What are equity mutual funds?
To generate returns, an equity mutual fund invests primarily in the equities of numerous companies. When compared to several forms of mutual funds, equity fund investments have a more significant risk. Furthermore, there is no such thing as ‘one-size-fits-all’ equity fund. Several different equity funds with varying investment objectives should be meticulously matched to your risk level.

Who should invest in equity mutual funds?
Anyone ready to take on a reasonable amount of risk in exchange for long term growth should invest in an equity fund. Because equity funds invest primarily in stocks, they are subject to market risks. This, on the other hand, enables them with the potential to provide significant returns to investors. Equity mutual funds are an investment avenue suitable for people who wish to leave their money in the hands of a fund manager and avoid the inconvenience of having to handle their investments themselves.

Suppose investors receive a better capital gain from their fund units. In that case, a dividend option is recommended since it will expand the number of units in the fund, resulting in higher returns in the future. Reinvesting your dividends is usually free of charge at most investment management organisations. If you want to secure regular returns on your investments, reinvestment is not a viable idea.

How do equity mutual funds work?
Equity mutual funds invest 60% of their assets in a variety of companies in appropriate proportions. The asset allocation will correspond to the investment goal. Depending on market conditions, the asset allocation can be solely in stocks of large-cap, small-cap, or mid-cap enterprises. Value and growth investing are two different investing styles.

Redemption

Let us assume that some investors elected to sell or redeem their stock. 50,000 units were redeemed in total. This led to a Rs 6 lakh outflow in terms of money. The fund’s AUM drops to Rs 1.14 crore, while its total number of units drops to 9.5 lakh. As can be seen, the NAV stays at Rs 12 per unit.

The financial advisor will first pay the investors from the portfolio’s cash balance to cope with the redemption. If necessary, he could also choose to sell some stock shares. On the other hand, most fund managers may only sell their stock holdings if they believe the company has no further upside potential.

Holding Period
When investors redeem their fund units, they realize capital gains. In the hands of investors, capital gains are taxable. The rate of taxes is determined by how long one remains invested, referred to as the holding period.

Short term equity holdings last less than a year, and short term capital gains are taxable at 15%. Long term equity holdings stay more than a year, and long term capital gains are taxed at a rate of 10% if they reach Rs 1 lakh per year.

Fall in NAV
Let’s hypothetically assume that the stock prices in the portfolio are falling. The portfolio’s value has dropped from Rs 1.14 crore to Rs 1.05 crore. The NAV has increased to Rs 11.05 per unit (1.05/95 lakh units).

A second investor contributes Rs 1 lakh to the scheme. He only obtained 9047.619 units for the same amount invested this time. With this transaction, the portfolio’s worth rises to Rs 1.06 crore. The overall number of units available under the scheme has increased by 9047.619 units.

We’ve broken them down into simple steps to make mutual funds easier to grasp. Hundreds of investors could buy or redeem units regularly in reality. The core operation, however, remains the same.

Cost of Investment
The expense ratio of equity funds is frequently impacted by frequent buyers and sellers of equity shares. For equity funds, the Securities and Exchange Board of India (SEBI) has set a limit of 2.5 percent. Investors will see higher returns if the expense ratio is lower.

Diversification
In case of equity mutual funds you obtain exposure to multiple stocks by building an investment portfolio, and you get this benefit for a small investment as well. Your portfolio, however, will be at risk of concentration.

Conclusion
For investors desiring expert management, mutual funds are a viable option. These also assist small investors in making regular savings. Investors may confidently begin investing with a better understanding of how mutual funds work.

Simply stated, equity mutual funds pool your money and invest it in companies after conducting extensive research. However, it is critical to comprehend the fundamentals of how equity funds operate. This includes understanding the equity fund’s goal and matching it to your risk profile. The fund’s asset allocation comes next, followed by its investing strategy. Last but not the least, you should be aware of the fund’s expenditure ratio, as it may affect the returns it may generate over time, and for that you could check out Axis Bank Mutual Funds.

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