Learn what equity mutual funds are, how they operate, their categories, tax treatment, and who should invest in them.
For years, Indian households quietly associated the word “investment” with fixed deposits.
But somewhere along the way, investing began to be viewed through a different lens. For first-time investors especially, equity mutual funds have gradually moved into the spotlight more recently.
These funds have become the default gateway for millions of Indians who want market exposure without picking stocks themselves. However, if you are new to these investment vehicles, gaining clarity on how equity mutual funds truly work becomes essential before committing your money.
This blog will guide you on the workings of equity mutual funds, their types, benefits, and more.
What are Equity Mutual Funds?
As their name suggests, equity mutual funds are investment vehicles that focus on the stocks or shares of publicly listed companies. They pool money from thousands of individuals like you and channel it into a diversified mix of companies and sectors across the Indian economy. This structure gives you access to the stock market without the hassle of tracking prices, researching businesses, or selecting stocks on your own.
The growing preference for this convenience and expert management is reflected in the industry’s scale. As of March 2025, the Indian mutual fund industry’s total assets under management (AUM) stood at ₹65.74 lakh crore, out of which ₹29.45 lakh crore was invested in equity and growth-oriented schemes alone.
The core objective of these funds is to help you achieve capital appreciation and build long-term wealth. And understanding how they operate is the key to seeing how this objective is achieved.
How do Equity Mutual Funds Work?
An equity mutual fund hires a skilled fund manager to manage the pooled funds. The fund manager’s goal is to achieve the underlying fund’s objectives. Generally, an equity mutual fund’s objective is to match or beat its benchmark index. For example, a Nifty Next 50 mutual fund’s objective would be to match or provide higher returns than the Nifty Next 50 index.
When you invest in an equity mutual fund, your money is converted into units, each priced at the fund’s Net Asset Value (NAV). The NAV represents the per-unit value of the fund and changes with the performance of its underlying portfolio.
As a result, the total value of your investment is simply the number of units you hold multiplied by the current NAV; rising or falling in line with it.
Apart from this, the underlying fund also charges an expense ratio to cover the fund manager’s fee and other operational costs. This charge is not paid separately but calculated as a percentage of your daily investment value. SEBI has capped the expense ratio for equity mutual funds in a range of 0.95% to 2.10%. Additionally, a one-time exit load is also applied when you redeem your units, with SEBI capping this charge at 3%.
Once you understand the costs involved in managing your investment, the next crucial information comes from knowing how your returns are taxed.
Tax on Equity Mutual Funds
Equity mutual funds in India are taxed based on how long you stay invested and the type of income you earn from the fund. If you sell your units within 12 months, the gains are classified as Short-Term Capital Gains (STCG) and are taxed at 20%. When you hold your units for 12 months or more, the gains qualify as Long-Term Capital Gains (LTCG) and are taxed at a reduced rate of 12.5%.
Apart from capital gains, any dividends you receive from your equity mutual fund are added to your total income and taxed according to the income tax slab you fall under.
In addition to these taxes, a Securities Transaction Tax (STT) of 0.1% is applied every time you buy or sell equity mutual fund units.
Once you understand how equity mutual funds are taxed, the next question is which type of fund suits your investment needs best.
Types of Equity Mutual Funds
Equity mutual funds can be classified in multiple ways depending on how they invest and the kind of companies they focus on. Broadly, they fall into two key types.
Based on Investment Style
Investment style describes the approach a fund follows in managing its portfolio and making investment decisions. Broadly, equity mutual funds are managed in two ways.
1. Actively managed funds
These funds rely on a fund manager who actively selects stocks with the aim of outperforming the market. Decisions taken in this fund are always based on research, analysis, and market opportunities.
2. Passive managed funds
Passive funds simply track a market index, such as the Nifty 50 or Sensex. Since they mirror the index instead of trying to beat it, they typically come with lower costs.
Apart from their investing style, equity mutual funds also differ based on market capitalization.
Based on Market Capitalization
Equity mutual funds invest across four major categories. Let’s take a look.
1. Large-cap funds
Large-cap funds invest 80% of their assets in the top 100 well-established and financially strong companies. These funds tend to offer relatively lower volatility compared to other equity categories.
2. Mid-cap funds
Mid-cap funds focus at least 65% of their money in the top 101 to 250 mid-sized companies that have strong growth potential. They offer higher return possibilities but come with moderately higher risk.
3. Small-cap funds
Small-cap funds invest at least 65% of their AUM in companies that are emerging with significant growth prospects and come after the top 251 mark.
4. Multi-cap funds
Multi-cap funds invest at least 25% in each category of large-cap, mid-cap, and small-cap stocks. This diversified approach helps balance risk while capturing opportunities across market segments.
Beyond exposure to the Indian economy, equity mutual funds come with several other valuable advantages.
Benefits of Investing in Equity Mutual Funds
Equity mutual funds offer several advantages that make them a preferred investment avenue for long-term wealth creation.
1. Professional management
Your money is managed by experienced fund managers who analyze markets, study businesses, and make informed decisions on your behalf.
2. Diversification
By spreading investments across companies and sectors, equity mutual funds reduce the impact of a single stock’s poor performance on your portfolio.
3. Long-term wealth creation
Equity funds tap into the growth potential of the stock market, offering investors like you the opportunity to build substantial wealth over extended investment horizons.
While these benefits make equity mutual funds attractive, it’s equally important to understand the risks involved.
Risks Associated with Equity Mutual Funds
Equity mutual funds often come across as riskier when compared to other traditional investments. This is why it is important to be aware of the risks that come with these funds before allocating any amount to these instruments.
1. Market volatility
Since these funds invest in stocks, market fluctuations can cause short-term ups and downs in your investment value.
2. Fund performance risk
In the case of actively managed funds, returns depend on the fund manager’s skills and the overall market conditions, which may not always align with expectations.
3. Category risk
Funds focused on specific segments, such as small-cap or sectoral themes, may experience sharper movements during market corrections.
Knowing where the risks lie makes it easier for investors like you to stay invested through market cycles and make informed investment decisions.
Final Thoughts
Equity mutual funds give you direct access to a professionally managed portfolio. That said, no two equity funds are built the same. Each comes with a distinct objective, which is why choosing a fund that aligns with your financial goals is very crucial.
You should also remember that equities cannot carry your entire portfolio alone. While they help you build wealth over the long run, pairing them with steadier debt instruments, like bonds, can give your portfolio the stability it needs when markets turn volatile.
