Why Are Equity Mutual Funds Suitable For Long-Term Goals?

Last Updated: 28 Oct 2024

Equity Mutual funds, known for their high return potential and their risk possibility, are exchange-traded funds (ETFs) that invest majorly in equity and equity-oriented instruments. As per SEBI guidelines, any fund that invests 65% or more of its corpus in equity is referred to as equity fund. Since these funds invest majorly in equity, they are known for their higher return potential. However, many people are unaware that they, in fact, perform better in the long-term.

Let’s look at a few factors that make these the best long-term investment option.

Equity Funds Helps Your Portfolio Grow Faster Than Inflation:

One of the most important reasons for choosing any investment product is to grow your capital at a faster pace than inflation. Inflation is the rate at which goods and services are getting more expensive every year. When the investment you make is not able to cross it, you end up losing money eventually even if the return gives you a positive return. To understand this, let us look at the example mentioned below.

Assuming the inflation in a year is recorded at 7%, and you invest in 4 different products that give you varying returns.

Investment Product	Appreciation YOY (%)	Inflatio(%)	Inflation-Adjusted Capital Growth (%)
A	5	7	-2
B	7	7	0
C	10	7	3
D	15	7	8

As you can see in the table, only investment products C and D are able to beat the inflation rate to generate positive capital appreciation.

Equity funds, known for their higher return potential, are better positioned to beat inflation compared to most other investment tools.

Build A Diversified Portfolio With Equity Funds:

Achieving a long-term financial goal requires you to build a robust portfolio that helps you stay on track. What you need is a portfolio that has just the right mix of risk-reward ratio.

Investing in equity mutual funds allows you to diversify your portfolio by investing in various types of equity funds that have different risk-reward potential. To understand this, let us examine a few types of equity funds and compare them in terms of their potential risk-reward ratio.

Type of Equity Fund	Features	Reward Potential	Risk Possibility
Large-Cap Fund	These funds invest majorly in mid-cap companies	Moderately High	Moderate
Mid-Cap Fund	These funds invest majorly in small-cap companies	High	High
Small-Cap Fund	These funds invest majorly in small-cap companies	High	High
ELSS Fund	These funds allow investors a deduction of up to Rs 1,50,000 from their taxable income	Moderately High	Moderate to High
Equity-oriented Balanced Funds	65% or more of the fund is allocated to equity and the rest to debt	Moderate	Moderate to Moderately High
Index Fund	Passively managed funds that aim to match the index they follow by investing in equity in the same proportion as the index.	Moderate to High	Moderate to High

As a thumb rule, the higher the return potential of the fund, the higher will be the risk possibility. However, since there are so many types of equity funds that cater to different goals, you can build a diversified portfolio that has a fair mix of high return mutual funds and low-risk funds to give you the desired long-term result.

Taxation Benefits On Equity Funds

Another important reason investors prefer equity funds for long-term investment is the taxation benefits that these funds enjoy.

Type of Fund	Short Term	STCG Tax	Long term	LTCG Tax
Equity Fund	Investments held for less than a year	15% on capital appreciation	Investment held for more than one year	10% on capital appreciation above Rs 1,00,000 in a year
Debt Fund	Investments held for less than 36 months	20% on capital appreciation after indexation	Investments held for more than 36 months	As per the income tax slab of the investor

As you can see, long-term capital gains tax on equity funds is zero if the capital appreciation is less than 1-lakh in a year. Beyond this, they are taxed at 10%. In the case of debt funds, the LTCG tax is as per the income tax slab which may be more than 10%, if your income in a financial year exceeds Rs 7.5 Lac. Moreover, you have to remain invested in a debt fund for 3 years for it to be termed as a long-term investment. The same time period is much shorter in the case of equity funds- it is just 1 year.

Apart from this, ELSS funds give specific tax breaks to the investor. Investments of up to Rs 1.5 Lac in a year can be deducted from the taxable income under section 80C of the Income Tax Act.

Equity Funds For Long-Term Capital Appreciation

While equity funds carry with them a risk possibility, they are also known to offer better capital appreciation. They are known to average out the losses and profits in the equity market to give positive growth to an investor. Thus, you should build a diversified portfolio with a healthy mix of low-risk and high-return mutual funds in India to achieve your long-term financial goals. By downloading a trading app, you can effectively monitor your investments and make informed decisions.