An equity fund is a form of mutual fund or exchange-traded fund (ETF) that invests in stocks rather than bonds. You may not be familiar with equity funds as a novice investor, but understanding about them should be one of your first financial goals. You will be more informed when investing if you understand the basics of how they work and how to invest in them.
What Is an Equity Fund, Exactly?
An equity fund is an open-end fund, such as a mutual fund or ETF, or a closed-end fund, such as a unit investment trust (UIT), that invests in businesses (thus the term “equity”).
A bond fund, often known as a fixed-income fund, is predominantly invested in bonds.
Traditional mutual funds and exchange-traded funds are both options for purchasing equity funds (ETFs). Some investors prefer one over the other, although both have benefits and drawbacks, depending on the mutual fund’s structure and the investor’s financial goals and circumstances.
How Does an Equity Fund Operate?
An equity fund strategy entails investors contributing funds to a fund, which pools the funds and invests them in equities, allowing investors to profit (or the losses).
The companies in the equity funds are chosen based on the fund’s aim and investment strategy, which can vary significantly.
Consider Fund A, which invests based on market capitalization and follows a growth investing strategy. It could invest in small-cap stocks, which have a higher growth and volatility potential than large-cap equities.
All equity funds, on the other hand, have one thing in common: capital appreciation, or a gain in the value of the investment. Bond funds, on the other hand, are intended to generate income for the investor.
Types of Equity Funds
Stock funds are divided into three categories: those that focus on market capitalization or geography, and those that follow a certain investment philosophy.
A. Market-Capitalization-Focused Equity Funds
Market capitalization, also known as market cap, is a measurement of a company’s worth based on its share price and number of outstanding shares. As a result, they are stock funds that invest in firms with a specific capitalization range, such as:
• Mega-cap equity funds: These funds invest in firms with a market capitalization of $200 billion or more, which are typically industry leaders. Consider Apple (AAPL) and Google (or Alphabet, GOOG), as well as Tesla (TSLA) (TSLA).
• Large- cap equity funds: Large-cap equity funds, which are one rung below mega-cap funds, invest in firms with a market cap of $10 billion to $200 billion, such as General Electric (GE), Starbucks (SBUX), or Delta Air Lines (DLX) (DAL).
• Mid-cap equity funds: These funds invest in firms with a market capitalization of $2 billion to $10 billion, such as Crocs (CROX) or Spirit Airlines (SAVE).
• Small-cap equity funds: These invest in firms with a market capitalization of $300 million to $2 billion, such as Unisys Corporation (UIS), however many of these aren’t famous names.
• Micro-cap equity funds: invest in small publicly traded companies with a market capitalization of $50 million to $300 million.
B. Geography-focused equity funds
These funds invest in firms from throughout the world, including:
• Global or worldwide equity funds: These hold stocks from all over the world, including those from the United States. They usually don’t differentiate between domestic and overseas assets, instead following the portfolio manager’s or investment methodology’s lead. In fact, some of the funds invest as much in US companies as domestic equity funds. 4
• International equity funds: These funds solely invest in stocks outside the United States.
• Nation or regional equity funds: These domestic funds invest entirely in stocks from the investor’s and issuer’s home country or region. A country equity fund, for example, would invest in China, while a regional fund would invest in Asia as a whole.
C. Investing Style-focused Equity Funds
These are funds that select companies using one of four basic methodologies: top-down strategy, bottom-up strategy, growth strategy, or value approach. The following are some of the most notable funds that have adopted each strategy:
• Sector- or industry-specific equity funds: These funds frequently use a top-down technique to select the best stocks in a given industry or sector. This can be enticing to investors who wish to put their money into specific types of enterprises, which isn’t always a terrible idea because certain industries have historically delivered disproportionately high returns for their owners.
• Equity income funds: These funds frequently use a bottom-up method in which they look for businesses that generate a significant dividend, regardless of industry. These funds are intended to provide income rather than capital growth to investors.
• Growth funds: These funds follow the growth approach, investing in stocks that have a proven track record of profitability and growth, such as those in the technology industry, and are projected to continue doing so.
• Value funds: These funds follow the value strategy, which entails buying inexpensive stocks with the potential to grow significantly in the future.
What is the Best Way to Invest in Equity Funds?
Check out the fund offerings at major providers before you buy if you decide to invest in equity funds. In general, you want an equity fund that has the following characteristics:
• Low fees, as indicated by the expense ratio and the absence of a sales load
• A broadly diversified portfolio
• Portfolio managers who invest a majority of their net worth in the same assets as you, putting their money where their mouth is
• A clearly defined mission so that you understand the types of assets it acquires, the reasons it acquires them, and the reasons it sells them
• A track record of consistent portfolio management
When it comes to investing, you have a few options to consider.
• Open an account with a mutual fund family directly.
• Open a brokerage account and purchase shares in an equity fund.
• Invest in an equity fund through your company’s 401(k) or 403(b) plan.
• At a brokerage firm, open a Roth or Traditional IRA and use it to purchase shares of an equity fund.
Each year, stock mutual funds and ETFs deliver nearly all of their dividend income (if any) to shareholders. As a result, you must consider your entire return rather than just the share price, which might be misleading depending on the amount of distributions made over time.
Almost all brokerage firms and mutual fund companies will allow you to automatically reinvest any payouts, in whole or in part, into more shares of the fund, increasing your total ownership over time.
The starting investment amount for these funds varies, although it is frequently as low as $1,000. By enrolling in automatic investments, you can typically reduce that minimum to $50 or even less. There are a number of ETFs that are similar to equities mutual funds, but you can trade them from your own brokerage account for a modest price.