| Average Real Return 1974-2023 | Average Real Return 2014-2023 | Years of Positive Returns since 1928 (%) | |
| S&P 500 | 8.42% | 9.98% | 67% |
| 10-Year Treasurys | 2.73% | -0.78% | 56% |
| Investment Grade Corporate Bonds | 4.87% | 2.01% | 71% |
| Real Estate | 1.61% | 4.16% | 56% |
| Gold | 4.11% | 3.32% | 41% |
A major benefit of investing in equity funds is diversification, a risk management strategy that involves spreading investments across a range of assets. This helps minimize the impact of any single investment’s performance on the overall portfolio. By investing in various stocks across different industries and sectors, equity funds help mitigate the risks of investing in individual stocks.
For example, if you hold a single stock that experiences a significant decline in value, your entire investment is at risk. However, if you hold an equity fund that includes that same stock with many others, the impact of its decline on the overall fund performance is reduced.
It’s important to note that historical returns are not guaranteed, and past performance does not necessarily predict future results. The stock market experiences short-term fluctuations and periods of volatility, which can impact the performance of equity funds. In addition, individual equity funds may perform differently than the broader market.
Potential Risks
While equity funds offer prospects for attractive returns, they also come with risks to consider. The main one with equity funds is market risk, which is that economic downturns, geopolitical events, or changes in investor sentiment can cause prices to decline. During market turbulence, equity fund prices can fluctuate significantly, potentially leading to short-term losses for investors.
You can manage this risk by maintaining a long-term investment perspective, regularly reviewing and rebalancing your portfolio as circumstances change, and ensuring that your equity fund investments align with your risk tolerance and financial goals.
It’s also essential to conduct thorough research and due diligence when selecting equity funds while considering the fund’s investment strategy, management team, historical performance, and fees. Management fees and loads (commissions) can eat into your returns over time.
Tax Implications of Equity Funds
Equity funds generate returns through capital gains and dividends, which are taxed differently. Short-term capital gains, resulting from the sale of securities held for one year or less, are taxed at your ordinary income tax rate, while long-term capital gains, from securities held for more than one year, are taxed at a lower rate. Dividends can be qualified or non-qualified, with qualified dividends taxed at the lower long-term capital gains rate and non-qualified dividends taxed at the ordinary income tax rate.
You can employ several strategies to minimize the tax impact of your fund investments. One is to hold equity funds in tax-advantaged retirement accounts, such as 401(k) plans or individual retirement accounts, which offer tax benefits like tax-deferred growth or tax-free withdrawals. Another is to invest in more tax-efficient fund structures, such as index funds or ETFs, which typically have lower turnover and generate fewer capital gains distributions. Consult with a tax professional or financial advisor for a personalized tax strategy that aligns with your financial goals and investment portfolio.
How To Invest in Equity Funds
Investing in equity funds is straightforward, but it requires careful consideration and research to select the right funds for your financial goals and risk tolerance.
1. Investment Objectives and Select the Fund Style
The first step is determining your investment goals, risk tolerance, and time horizon. Your investment objectives should align with your financial goals, such as saving for retirement, funding a child’s education, or building long-term wealth. Risk tolerance refers to your ability and willingness to withstand market volatility and potential losses in pursuit of higher returns. Time horizon is the length of time you plan to hold your investments before needing to access the funds.
Once you understand these factors, you can narrow down your equity fund choices. Consider the different types of equity funds available, such as actively managed, passive index, or sector-specific funds, and determine which best aligns with your goals and risk profile. For instance, a young professional with several decades before retirement might want a higher-risk growth fund with active management, while someone nearing retirement might want a more conservative value fund or broad-based index fund.
2. Research and Analyze Potential Funds
Conducting thorough research and analysis is always important for making informed investment decisions. Start by reviewing the fund’s prospectus, a legal document providing detailed information about the fund’s investment objectives, strategies, risks, and fees. The prospectus can typically be found on the fund company’s website or through financial news and research platforms.
In addition to the prospectus, review the fund’s annual and quarterly reports, which provide updates on the fund’s performance, holdings, and market commentary. These reports offer valuable insights into the fund’s management style and decision-making process.
Review financial news and research platforms like Morningstar, Yahoo! Finance, and Investopedia to find fund performance data, analyst ratings, and comparisons to peer funds. Pay attention to key metrics such as the fund’s returns over various periods, volatility measures (such as standard deviation or beta), and risk-adjusted returns.
Consider the fund’s expense ratio, which is the annual fee charged by the fund, expressed as a percentage of assets under management. Higher expense ratios can significantly impact long-term returns, so comparing a fund’s fees to those in the same category is essential.
Most brokerages have mutual fund screeners that help you narrow down the thousands of fund options available based on your criteria.
3. Start Investing
Once you have selected an equity fund (or funds) to invest in, the next step is to open an investment account. You can typically open an account directly with the fund company or through a brokerage firm that offers access to a wide range of funds from multiple providers.
- To open an account, you must provide personal information, such as your name, address, date of birth, and Social Security number. You will also need to fund the account by transferring money from a bank account or another investment account.
- Once your account is open and funded, you can buy shares of the desired equity fund. Many funds have a minimum initial investment requirement, ranging from a few hundred to several thousand dollars. Some funds also offer automatic investment plans, which allow you to invest a fixed amount regularly (e.g., monthly or quarterly) to help build your position over time.
- After placing your order, you will receive confirmation of your purchase, including the number of shares bought and the price paid per share. Monitor your investments regularly, reviewing fund performance, holdings, and relevant news or market developments. Consider rebalancing your portfolio periodically to ensure that your equity fund allocation aligns with your target asset mix and risk profile.
Mutual fund trades are executed once a day, at the close of trading, priced at the fund’s net asset value, or NAV.
How Do Equity Funds Provide Diversification?
Equity funds provide diversification by investing in a wide range of stocks across different sectors and industries. By spreading investments among companies, funds reduce the impact of any single stock’s poor performance on the overall portfolio. This diversification reduces the unsystematic risk associated with investing in individual stocks, as the success or failure of one company has a limited effect on the fund as a whole.
How Can I Choose an Equity Fund that Aligns with My Investment Goals?
To choose the right equity fund for your investment goals, assess your risk tolerance, time horizon, and financial goals. For example, suppose you are a young investor with a long time horizon and a high risk tolerance. In that case, you may consider investing in an actively managed small-cap growth fund that seeks to capitalize on the potential of emerging companies. Meanwhile, if you are nearing retirement and prioritize income generation and capital preservation, a large-cap value fund focusing on mature, dividend-paying companies may be more appropriate. Look for funds with a proven track record, experienced management teams, and investment philosophies that align with your own. For example, if you value socially responsible investing, you may want equity funds that incorporate ESG criteria into their choice of investments.
What Was the First Equity Fund and Does it Still Exist?
The first modern equity fund was the Massachusetts Investors Trust, established in Boston in 1924 by Edward G. Leffler and Ashton L. Carr. The fund was designed to allow smaller individual investors to pool resources and invest in diversified portfolio of stocks, which was previously only available to wealthy individuals or institutions. The Massachusetts Investors Trust still exists and operates under the name MFS Massachusetts Investors Trust and is managed by MFS Investment Management.
What Is the World’s Largest Equity Fund?
As of the second quarter of 2024, the largest equity fund (also the largest mutual fund) is the Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX). This mutual fund tracks the performance of the entire U.S. stock market, providing investors with broad exposure to large-cap, mid-cap, and small-cap stocks. As of April 2024, the fund held more than $1.5 trillion in assets under management.
The Bottom Line
Equity funds offer a convenient way to gain exposure to a diversified portfolio of stocks, with the potential for higher returns than bonds or cash. Investors can choose between actively managed and passive funds, funds that invest in a range of company sizes, growth vs. value orientation, and sector- or geographic-specific funds. However, investing in equity funds also carries risks, primarily because of the stock market’s higher volatility. Before investing in equity funds, it’s essential to consider your investment objectives, risk tolerance, and tax situation. As with any potential investment, consult with a financial advisor to help determine how equity funds may fit within your overall financial strategy, and always conduct thorough research before making any investment decisions.
