The reason most investors prefer equity funds is because they predominantly invest in stocks yet offer diversification as compared to direct equities. One single unit of an equity mutual fund is a combination of multiple stocks. For example, if you invest in an equity fund that invests in Tata Motors, Apollo Hospital, and Infosys, one single unit of that equity scheme will be an amalgamation of these three companies’ stocks. Equity funds invest majority of their investible corpus in equity and equity related instruments. Although they are highly volatile over the short term, equity funds have outperformed all other investment avenues over the long term.
Here are some of the pros and cons of investing in equity mutual funds. Let us start with the pros.
Pros of investing in equity mutual funds
Equity funds invest in a diversified portfolio of securities
As stated earlier, the biggest advantage of equity funds is that they invest in a diversified portfolio of securities. Equity funds offer active risk management by mitigating the overall risk of the portfolio. By investing in multiple company stocks, the scheme avoids ‘stock specific risk’. Even if one underlying asset underperforms, investments in other assets can even out the losses.
Under professional management
The reason most retail investors prefer equity funds is because they lack the knowledge of investing in the stock market. An equity fund manager, along with the help of market experts and analysts, picks stocks that have the potential to generate capital appreciation over the long run. The professionals put their years of experience to work in ensuring that the scheme is able to outperform its underlying benchmark.
SIP investment option
The biggest advantage of investing in equity mutual funds is that you can make small systematic investments at periodic intervals by starting a monthly SIP. Systematic Investment Plan is preferred by most individuals are compared to lumpsum investment for various reasons. With SIP, one doesn’t need to have a large capital for making the initial investment. There are some schemes where you can invest an amount as little as Rs. 500 per month. SIPs might inculcate the discipline of investing regularly for the long run. Long term investing in equity mutual funds via SIP might allow investors to benefit from various investment techniques like rupee cost averaging and power of compounding.
Drawbacks of investing in equity mutual funds
Retail investors lack ownership
When you buy shares of a company, you own a stake in that company irrespective of whether the company earns profit or face losses. When you buy shares, you become the shareholder of the company. There’s no such thing when investing in equity mutual funds. Those who invest in an equity mutual fund, they are allotted units and become unitholders of that particular equity mutual fund. Investors cannot own the underlying stocks the form the investment portfolio of an equity mutual fund.
Expense ratio is high
Since equity funds are actively managed, they carry a relatively high expense ratio. An expense ratio consists of all the recurring costs and management costs that must be taken care of so that the scheme to run smoothly. At the time of investment, the expense ratio may not seem like a big deal, but it does have the tendency to take a big chunk of you long term gains.
Like any other mutual fund scheme, equity funds do not offer guaranteed returns. Investors are expected to not depend on any one asset class for creating wealth. Depending on your risk appetite, ensure that you diversify your investment portfolio with the right mix of equity and debt.