Why Equity Mutual Funds Are Best for Long-Term Wealth Creation

When it comes to wealth creation on a large and permanent scale, equity mutual funds have proven to be a very favorite form of investment in India. By collecting funds from many investors and investing heavily in equities, the funds provide a very ideal vehicle for long-term growth. Equity mutual funds are investments made to help increase one’s wealth while diversifying some of the risk. Here we shall talk about why the equity mutual funds are most in demand of all to accumulate wealth in the long term and talk about how tax, especially on short-term capital gains, affects the overall investment plan.

The Basics of Equity Mutual Funds

Equity mutual funds invest in listed company shares belonging to different groups of industries. The stocks are selected by the fund managers after thorough market study and research for achieving good returns in the long term. The equity funds have sub-segments such as large-cap, mid-cap, small-cap, diversified equity, sectoral, and thematic funds depending on the financial goal and risk-taking capacity of the investor.

The stock market also has a tendency to give more returns than conventional saving devices like FDs or PPF. But with greater returns comes volatility. It is volatility that will also drive away the investors with short horizons but reward the investors who remain invested at longer horizons.

Why Investment in Equity Mutual Fund over Long Time Period Succeeds

Compounding Effect

Compounding effect will definitely be the highest return of investing in an equity mutual fund in the long term. If the profit in terms of dividend and capital gain is reinvested, returns over returns are earned, and growth occurs exponentially.

For example:

• Imagine investing ₹1,00,000 in an equity mutual fund that has an average return of 12% per annum. After 10 years, your investment could swell to approximately ₹3,10,000 if the returns are consistent and compounded.
• A 20-year period would yield almost ₹9,65,000, showing how compounding builds wealth over a longer period.

Less Impact of Market Volatility

Equity markets are quite volatile. Short-term supply-demand volatility, monetary policy, and geopolitics cause the fluctuations. But markets balance out over the long term. Allowing your money to ride through the cycles tends to attract huge long-term action. The Indian stock market, as represented by indexes such as Nifty 50 and Sensex, has yielded a return of approximately 12-15% per year over the duration of the last twenty years, which is not obtained by any other asset class.

Portfolio Diversification

Equity mutual funds yield built-in diversification. Instead of investing in individual stocks directly, which is not advisable, mutual funds spread your money across a basket of companies of different sizes and sectors in the market. Diversification reduces the impact of the weakness of certain stocks or industries, and as a result a safer means to accumulate wealth.

Long-Term Capital Gains Tax Advantage

Despite its prominent contribution in net returns, equity mutual funds possess comparatively friendly tax benefit in Indian taxation systems. Investments lasting over one year are considered long-term investments and are subject to LTCG tax.

Based on current tax rules:

• LTCG in equity mutual funds is taxed at 10% but only in case of earnings over ₹1,00,000 in a fiscal year.

Example:

• If an investor gets ₹3,00,000 as long-term capital gain (after 12 months), tax paid would be:
  ₹3,00,000 – ₹1,00,000 (exempt) = ₹2,00,000 taxable.
  Tax paid = 10% of ₹2,00,000 = ₹20,000.

Short-term investments (less than a year) are taxed at a higher rate. Short-term capital gains tax (STCG) on equity mutual funds is 15% irrespective of quantum of gain, which may not be of that much use in wealth creation.

Better Rupee-Cost Averaging

Occasional investment in SIPs also results in wealth creation. SIPs help the investor to invest a fixed sum of money periodically and enjoy the benefit of rupee-cost averaging in the event of a fall in the market. With the passage of time, even if the market fluctuates, average cost levels out and returns are optimized.

Short-Term Investments: Drawbacks of Equity Mutual Funds

Short-term equity mutual fund investing, while profitable, is wealth-decreasing. The 15% rate of short term capital gains tax on short-term capital gains will slice deeply into the after-tax return. Further compounded to this is the market volatility for the shorter period of time, thus short-term investing is riskier and does not typically gain from compounding.

Alternative for this, active purchase and sale has a price in the form of exit charges (paid on early redemption of investments) and trading charges, which also eats into the profits. These hurdles make equity mutual funds suitable for long-term participants who are willing to be patient to let the investments mature.

Empirical Data: Long-Term vs. Short-Term Investments Compared

Suppose two investors investing ₹1,00,000 in equity mutual funds

• Investor A: Hols on for 1 year, earns 15% (₹15,000 as STCG). On the payment of 15% tax on STCG, they pay ₹15,000 × 0.15 = ₹2,250 as tax and receive ₹12,750.
• Investor B: Hols on for 5 years, at 12% p.a. rate of interest after compounding:

₹1,00,000 × (1 + 12%)^5 = ₹1,76,234.

LTCG (assuming profit over ₹1,00,000 exemption):
₹76,234 × 0.10 = ₹7,623 as tax.

Net after-tax returns = ₹68,611.
Investor B’s long-hold strategy reaps higher returns, demonstrating the long-term benefits of wealth building.

Summary

Equity mutual funds have been an excellent investment option in India for generating wealth in the long run.

The plans invest primarily in equity shares of listed firms, which are bound to grow substantially on the strength of market appreciation and compounding effect. Diversification reduces risk, and tax advantage such as reduced long-term capital gains tax is for further enhancing returns after tax. In contrast to short-term investments, long-term investments treat investors well at high and low levels in the markets and provide steady growth. For instance, a ₹1,00,000 investment carrying an interest rate of 12% per annum would be ₹3,10,000 after 10 years and ₹9,65,000 after 20 years. Income received over long periods of years is taxed at 10% over an exemption of ₹1,00,000 per year, while short-term investments are taxed more at the mode of 15%.

Equity mutual funds denote patience and foresight are needed in an attempt to generate wealth in gigantic proportions. Risks and rewards must be balanced and reconciled with prudence in accordance with investors’ financial goals and taken experts’ views wherever needed.

Disclaimer

Financial investment in financial markets is always risky, and past history never gives guarantees of future performance. The article never gives any guarantees of financial performance and must never be used as professional money advice. The investors have to read individual financial circumstances, understand each risk, and consult professionals before proceeding.

About the Author

Sweta

Administrator

Visit Website View All Posts