Equity Mutual Funds — Part 1: The Basics

If you landed here directly, it would be better for you to read Basics of Investing before reading about Equity Mutual Funds.

What is a Mutual Fund?

A Mutual Fund is an investment avenue that pools money from its investors and then goes ahead and buys other instruments like Stocks, Bonds, and Securities with the pooled money.

These are managed by Asset Management Companies (AMC) which appoint Fund Managers — professionals who are experts in their fields. Think of it like this: instead of you trying to pick individual stocks (which requires time, knowledge, and constant monitoring), you hand over your money to a professional who does this full-time for thousands of investors like you.

Mutual funds can be categorized in multiple ways, but the most basic classification is based on what they invest in:

• Equity Funds — primarily invest in stocks
• Debt Funds — primarily invest in bonds and fixed-income securities
• Hybrid Funds — a mix of both

We will focus on Equity Funds in this series.

Are Mutual Funds Safe?

Let us address the most basic question — "Will they run away with my money?"

The short answer: No, they cannot.

Mutual funds in India are among the most well-regulated financial products. The regulatory framework ensures that your money is protected:

1. SEBI (Securities and Exchange Board of India) regulates and monitors all Asset Management Companies.

2. AMFI (Association of Mutual Funds in India) sets ethical standards and best practices.

3. Strict entry barriers — Not just anyone can start an AMC. There are rigorous criteria including track record, experience, and capital requirements.

4. Segregation of assets — The AMC manages the fund, but your money is held by a separate custodian. Even if an AMC goes bankrupt, your investments remain protected.

5. Daily NAV disclosure — The Net Asset Value is published every day, so you always know what your investments are worth.

6. Regular audits — Funds are audited regularly and must disclose their complete portfolio.

The key word here is temporary. Historically, over long periods (5+ years), well-managed equity funds have generated wealth. But in the short term? Anything can happen.

Why Equity Mutual Funds?

If equity means volatility, why bother?

Because over the long term, equity as an asset class has consistently beaten inflation and other asset classes.

Let me share some numbers to put this in perspective:

Look at the last row. If inflation is 6% and your FD gives you 7%, your real return is only 1%. Your money isn't really growing — it's barely keeping up.

But here's the catch: You need to stay invested for the long term. Equity rewards patience and punishes impatience.

Types of Equity Mutual Funds

SEBI has categorized equity mutual funds to bring standardization. Here are the main categories you should know:

By Market Capitalization

Large Cap Funds

• Invest in the top 100 companies by market cap
• Think Reliance, TCS, HDFC Bank, Infosys
• More stable, less volatile
• Good for: Conservative equity investors, first-time investors

Mid Cap Funds

• Invest in companies ranked 101-250 by market cap
• Growing companies with potential
• More volatile than large caps, but potentially higher returns
• Good for: Investors with moderate risk appetite and 7+ year horizon

Small Cap Funds

• Invest in companies ranked 251 and below
• High risk, high potential reward
• Can fall 40-50% in bad times, but can also give exceptional returns
• Good for: Aggressive investors with 10+ year horizon and strong stomach

Flexi Cap Funds

• Can invest across all market caps
• Fund manager decides the allocation
• Offers flexibility and diversification
• Good for: Most investors, especially beginners

Large & Mid Cap Funds

• Mandated to invest in both large and mid caps
• Balance between stability and growth
• Good for: Moderate risk investors

By Investment Style

Index Funds

• Simply mirror an index (like Nifty 50 or Sensex)
• No active fund manager decisions
• Very low cost
• Returns will match the index (minus small expenses)
• Good for: Believers in passive investing, cost-conscious investors

Actively Managed Funds

• Fund manager actively picks stocks
• Tries to beat the index
• Higher cost than index funds
• Some beat the index, some don't
• Good for: Those who believe in active management

Special Categories

ELSS (Equity Linked Savings Scheme)

• Offers tax deduction under Section 80C
• 3-year lock-in period (shortest among 80C investments)
• Invests like a diversified equity fund
• Good for: Tax saving + wealth creation

Sectoral/Thematic Funds

• Focus on specific sectors (IT, Pharma, Banking, etc.)
• Very concentrated, very risky
• Can give spectacular returns or spectacular losses
• Good for: Experienced investors who understand the sector

The Power of SIP (Systematic Investment Plan)

We touched on this in Basics of Investing, but it deserves emphasis here.

SIP is the single most important concept that makes equity investing accessible to ordinary people.

Instead of investing a large amount at once (and worrying about timing), you invest a fixed amount every month, regardless of where the market is.

How SIP Helps

1. Rupee Cost Averaging — When markets are high, your SIP buys fewer units. When markets fall, your SIP buys more units. Over time, this averages out your cost.

2. Removes timing anxiety — You don't need to predict whether the market will go up or down.

3. Builds discipline — Automating your investments means you don't "forget" to invest.

4. Starts small — You can start with as little as ₹500 per month. No excuses.

Here's a simple illustration:

Average NAV over 5 months = ₹95

Your average cost per unit = 25,000 ÷ 266.14 = ₹93.94

Direct vs Regular Plans

Every mutual fund scheme comes in two variants:

• Regular Plan — Includes distributor commission
• Direct Plan — No distributor commission

The underlying portfolio is identical. The only difference is cost.

1% may sound small, but compounded over 20 years on a large corpus? It's lakhs of rupees.

Growth vs IDCW (Dividend) Option

Another choice you'll encounter:

Growth Option

• All profits stay invested in the fund
• NAV keeps growing
• Better for wealth creation
• More tax-efficient for long-term investors

IDCW (Income Distribution cum Capital Withdrawal) Option

• Fund periodically pays out some profits
• NAV doesn't grow as much
• These payouts are taxed as income
• Not really "dividends" — it's your own money coming back to you

Key Takeaways from Part 1

1. Mutual funds are safe from fraud, but not from market volatility. That's by design.

2. Equity beats inflation over the long term, making it essential for wealth creation.

3. Start with simpler categories — Flexi Cap, Large Cap, or Index Funds. Avoid sectoral/thematic funds initially.

4. SIP is your friend — It removes timing anxiety and builds discipline.

5. Go Direct if you can, and choose Growth option for wealth building.

Coming Up in Part 2

Now that you understand what equity mutual funds are and their basic types, the next question is: How do you choose one?

Part 2 will cover:

• Why you should start with one "boring" fund
• Why chasing "best performing" funds is a trap
• What actually makes a fund good (hint: it's not last year's returns)
• A simple framework to pick your first fund

To be continued...