When it comes to investing in mutual funds, data suggests that investors are highly inclined to invest in equity funds. As per the quarterly data for July - September 2022, about 9.2 crore folios featured equity schemes across the mutual fund industry, with the total Assets Under Management (AUM) of ₹14.64 lakh crores. In comparison, the number of folios in debt-oriented schemes stood at around 72 lakh. (Source: AMFI)
Equity funds create an underlying portfolio of equity shares predominantly, and investing in equity funds may be primarily attributed to the inherent advantages of equity funds for financial planning.
Here are five advantages of equity mutual funds:
Professional fund management
When it comes to equity investing, it is often advised that one should invest directly in equity shares only if one understands the nuances of equity markets. Instead, one may take the equity mutual funds route, availing professional fund management and enjoying the potential of better returns than traditional investment instruments like FDs, over the long term.
Portfolio diversification
Investing in equity mutual funds allows one to enjoy exposure to multiple stocks with a single investment product, thereby achieving portfolio diversification. The fund managers choose such stocks based on the companies’ fundamental strength, the growth potential of the individual stocks, and the scheme's investment objective. Portfolio diversification may help investors mitigate certain investment risks, since different stocks may react differently to similar situations, events, etc.
Systematic investments
Equity funds allow the convenience of investing through Systematic Investment Plans (SIPs). Investors can register an SIP in equity mutual funds for an amount as low as ₹100 in specified periodicities, viz. daily, weekly, monthly, etc., in specific mutual fund schemes.
This inculcates a sense of financial discipline, as investments are regularly made irrespective of market movements. Similarly, investors may also register an SWP (Systematic Withdrawal Plan) to withdraw their investments periodically to fulfil the regular cash flow requirements once the desired investment corpus is achieved.
Tax Benefits on investment
As per the income tax laws, investment in a specified category of equity funds, viz. Equity Linked Savings Scheme (ELSS) is eligible for tax deduction under Section 80C of the Income Tax Act. Deduction for tax on equity mutual funds can be availed up to an amount of ₹1.50 lakhs in a financial year, for all the eligible payments/investments considered in aggregate.
ELSS Funds carry a lock-in period of 3 years from the date of investment and can be redeemed at the investor's request after the expiry of the lock-in period. However, since the investment is not automatically redeemed, investors can even link ELSS investments with their financial goals lasting beyond three years.
Special tax rates on equity fund returns
Equity mutual fund returns are taxed as capital gains at mutual fund units' redemption. Such gains are considered Short-Term Capital Gains (STCG) if the holding period (i.e., the time between the date of investment and redemption) is less than 12 months and taxed at a special rate of 15% (plus applicable cess and surcharge), irrespective of the tax rates applicable to the investor ranging up to 30%.
Similarly, Long-Term Capital Gains (LTCG) (for a holding period of 12 months or more) are taxed at 10% (plus applicable cess and surcharge). The tax laws also provide an exemption of ₹1 lakh every year towards LTCG from equity shares and equity-oriented mutual funds in aggregate.
Investors can aim for long-term wealth creation by looking at the above benefits of investing in equity mutual funds.
Who should invest in equity mutual fund schemes?
- Investors looking at a long-term investment horizon (more than five years) as equity funds may be volatile in the short term.
- Young investors who have a greater risk appetite and want to generate wealth for their future selves.
Disclaimer:
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Union Budget 2020 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.