It is well known that equity mutual funds provide an investor with advantages that are challenging to achieve through other investment vehicles. When selecting an equity portfolio, the market capitalization or the size of the company is one crucial factor as it ultimately determines the risks and advantages of investing in the company.
There are three main categories of equity mutual funds based on market capitalization that one can invest in – large cap, mid cap and small cap.
The Securities and Exchange Board of India (SEBI) has established guidelines and distinct lines of demarcation between each of the three categories, and its reclassification outlines all the changes that have been made to various investment funds.
Here’s how large cap mutual funds work and the factors one must consider before investing in them.
What Are Large Cap Funds?
Equity funds that invest a larger percentage of their total assets in organizations with a high market capitalization are known as large cap mutual funds. These companies enjoy a strong reputation and have a proven track record of providing wealth to investors over an extended period of time. Therefore, large cap funds are recognized to produce consistent dividends and stable wealth accumulation.
Additionally, these schemes have a lower risk profile than small- or mid-cap funds, and they are considered to produce more consistent returns. According to SEBI, large cap companies fall in the top 100 list of firms by market capitalization.
Who Should Invest In Large Cap Funds?
Large cap funds are often preferred by investors who make prudent use of their equity assets and who seek stability in their investments rather than highly volatile or fluctuating profits.
Investors must keep in mind that even the strongest large cap funds can occasionally fall short of the anticipated market return when compared to mid- or small-cap companies. However, large cap mutual funds can stand firm against any decline or reduction in market capitalization, owing to longer term investment horizons.
Investments in large cap funds are appropriate for people looking to diversify their portfolios by their fund managers. If an investment in one sector falls short of investors’ expectations, there are other sectors that could be invested in and lessen the negative impact. In comparison to small and medium-sized businesses, large cap funds generate lower returns since they are less risky and less volatile. It is a fantastic investment plan for new investors.
Factors To Consider Before Investing In Large Cap Funds
Research risk and return
Market conditions have an impact on all equity mutual funds. The net asset value (NAV) fluctuates along with the scheme’s benchmark. However, unlike mid and small cap funds, the NAV of large cap funds does not fluctuate significantly. Therefore, investing in large cap schemes provides stability to one’s portfolio of investments. Having said that, these plans often yield lesser returns than mid- or small-cap funds. Thus, one should invest in large cap funds if they desire stable returns at a lower risk exposure.
Know the expense ratio
The expense ratio is the cost that fund companies charge for managing one’s investment. It represents the portion of the fund’s total assets that are used for administrative and other fund management functions.
Fund houses are prohibited from charging expense ratios greater than 2.50%, according to SEBI’s mandate. One should seek a plan with a lower expense ratio so that it helps in maximizing returns.
Consider the investment period
Large cap funds also experience underperformance of their portfolios during market downturns. However, this underperformance averages itself out over time because the money is invested in financially sound organizations. Therefore, large cap mutual funds are often suggested to investors with long-term investment horizons.
Understand your financial goals
Large cap mutual funds provide consistent returns while posing a manageable level of risk. As a result, many investors use these schemes while planning their investments for retirement.
Taxation of large cap funds
Large cap mutual funds are taxed similarly to other equity funds. The dividends from large cap investments were tax-free up until the budget of 2020 as the fund houses had to pay the dividend distribution tax (DDT) before disbursing the necessary dividends to investors.
By restoring the traditional nature of the taxation of dividends in the investor’s hands, the Budget of 2020 modified this law. Investment fund dividends are included in one’s total income and taxed in accordance with the investor’s income tax bracket.
The retention period affects how much capital gains provided by equity funds is taxed. By selling the fund’s units within a year of purchase, one can generate short-term capital gains. Regardless of the kind of income tax, these gains are taxed at a flat rate of 15%.
Long-term capital gains arise when investments from equity funds are sold off after holding for a year or more. These profits up to INR 1 lakh are exempted from taxes. But profits that surpass this threshold are subject to a 10% tax rate, leaving no benefit of indexing.
Benefits Of Investing In Large Cap Funds
Diversification across several industries
Typically, large cap funds invest in a diverse portfolio of blue-chip stocks that are for the long-term and fund managers constantly monitor the performance of the funds.
Large cap stocks are known to weather fluctuating market conditions, while offering the benefit of adequate liquidity as and when the need arises.
Better capital growth
Since large cap funds invest in companies known for their outstanding business and financial performance, these funds generally provide appreciation over the longer term.
In a nutshell, large cap funds are ideal for investors, particularly novices, looking for capital appreciation over the longer term in stocks that have better risk appetite and to weather volatile market conditions. A long-term investment in large cap equity mutual funds — one that will last at least five to seven years — is the preferred investment period.