When we speak of mutual funds, it
is a common misconception that equity mutual funds form a major chunk of mutual
funds in terms of assets under management.
In reality, liquid and debt funds
form the major portion of asses under management in mutual funds.
This is because large
corporations, FII’s and HNI’s park a substantial sum in liquid and debt funds
as compared to equity funds.
Overnight and liquid funds provide
necessary security whereas short term funds make more sense with dwindling
fixed deposit rates.
What is an equity mutual fund?
An equity mutual fund is any fund that invests a minimum of
65% of its corpus in equities at all times.
Equity funds are funds that invest in listed shares of
companies.
Equity mutual funds carry the most risk among all mutual
funds but at the same time they also hold the potential to generate the highest
returns.
Only elss funds, also known as tax saving mutual funds need
to invest 80% of its corpus in equities at all times as opposed to 65% for
other equity mutual funds.
Equity mutual funds should ideally be opted for by investors
who:
- Have a long-term horizon
- Can stay disciplined
- Would not need the money within 5 years
- Can also invest via SIP
How do equity mutual funds work?
As previously mentioned, for a fund to qualify as an equity
fund it would need a minimum of 65% investment into equities at all times.
(except for elss funds)
Besides this general rule, there are certain other restrictions
as well.
- A small and mid cap fund at all times need a minimum of 65% investment in small and mid cap stocks.
- A large cap needs a minimum of 80% investment in large cap stocks at all times.
- A large & mid cap fund needs a minimum of 35% investment into each large and mid cap stocks.
- A multi cap fund needs a minimum of 25% investment into each large, mid and small cap stocks at all times.
All the above necessary mandate came into effect only after
mid 2018, prior to this there was no such restriction as such and therefore
mutual funds would move across various caps as per their wish without any
concern for mandate.
Therefore even an investor investing in a large cap fund could
get higher exposure to mid and small cap stocks.
Investors now know what they are getting into and even AMC’s
need to work within the purview of the mandate laid down for respective
categories.
A fund house cannot have more than one fund in the same
categories.
A flexi cap fund is the most flexible equity fund since it
is not bound by any cap whereas a thematic and sectoral fund can be said to be
the most restricted since they can invest only in companies that fall within
the sector or theme.
Stocks are classified as large, mid and small by AMFI once
every 6 months and AMC’s accordingly need to take cognizance of the same.
Equity
mutual funds taxation
Taxation for equity mutual funds can be better understood by
bifurcating it further into LTCG and STCG
LTCG
Long term capital gains tax also known as LTCG is charged on
equity mutual funds when the profits from equity mutual funds held for more
than a year are more than 1 lakh.
The LTCG rate is 10%.
Capital gains up to and under 1 lakh are exempted for taxes.
When calculating LTCG there is no benefit of indexation.
STCG
Short term capital gains or STCG is charged on gains from
equity mutual funds which are held for 12 months or less.
The STCG rate is 15%.
There is no ceiling benefit in STCG like the 1 lakh ceiling
in LTCG.
It is charged on from Re 1.
Taxation on international equity
mutual funds
International equity mutual funds are treated as debt funds
for tax purposes.
A 20% LTCG is charged on gains from International mutual
funds that have been held for more than 36 months.
STCG is charged on gains from International mutual funds
that have been held for less than 36 months.
The STCG is added to your income and taxed as per your
income tax slab.
Securities Transaction Tax
STT of 0.001% is charged on the sale of equity mutual funds.
Stamp
Duty
From July 1, 2020 onwards a stamp duty of 0.005% is deducted
on the investment amount of mutual funds for any transaction executed on or
after July 1 2020.
This is applicable on:
- Purchases
- Dividend Reinvestments
- Systematic Investment Plan (Inclusive of running SIP’s registered earlier)
- Systematic Transfer Plan
- Equity as well as Debt schemes
Additional reading: Click Here to read about why you should not invest in mutual funds based on past returns
Equity mutual fund returns
Irrespective of what category of mutual fund you invest in,
returns from mutual funds is not guaranteed.
Returns from equity mutual funds can vary drastically
depending mostly on the category you have invested it.
Within the category too, the difference between the fund
with the highest return and lowest return can vary largely since every fund
within the same category despite the same mandate can adopt different
strategies.
It is often said the funds with the highest risk also hold
the potential for high returns but that is a very narrow approach.
It is one thing for a fund with high risk to also hold
potential for high returns but completely another for you to be able to
withstand the volatility such high risk/high return funds carry.
As much as high returns is why you start investing in mutual
funds, not returns but goals should be ultimate goal for which you need your
portfolio to be aligned with your goals.
High risk or low risk, high returns or low returns, at the
end of the day what truly matters is how well constructed and managed your mutual
fund portfolio is.
This is because you never invest in just one mutual fund scheme,
you have a proper well diversified and balanced portfolio that consists of various
schemes.
Failure to do so would result in several issues like
constant chopping and changing which in turn would result in taxes, exit load
charges, not being able to fully utilize compounding benefits and so on.
Equity mutual funds, specifically the SIP mode of investing
in them is a great way to convert your money into long term wealth and
accomplish your long term goals.
India even today does not have a sizeable population
investing in them and even the ones doing so are going about it with half baked
knowledge and on the advice of those who themselves are not well versed with
mutual funds.
This poses a risk to all those involved, too many cooks
spoil the soup and there is a heightened need for the average retail mutual
fund investor to seek professional advice which imparts healthy checks and
balances.
For portfolio enquiries, email us with your doubts at info@themutualfundguide.com
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