# Beginner's Guide to Investing in Equity Funds: Tips and Types

> **Definition**
>
> An equity fund pools money from investors to buy a portfolio of stocks.

## What Is an Equity Fund?

Equity funds pool investors' money to buy a diversified portfolio of stocks, offering potential for long-term growth. By investing in various companies, these funds provide a balanced approach to stock market investing, reducing the risk associated with individual stocks underperforming. Managed by professionals, equity funds can be categorized by company size, fund management style, and market focus, making them an attractive option for investors with different goals and risk tolerances.

### Key Takeaways

*   Equity funds pool investors' money to invest in a diverse portfolio of stocks, offering potential for higher long-term returns.
*   There are two main types of equity funds: actively managed funds, which seek to outperform a benchmark index, and passive funds, which aim to mirror the market index's performance.
*   Equity funds can be categorized based on market capitalization, investment style (growth vs. value), and focus on specific sectors or geographic regions.
*   Although equity funds offer diversification and professional management, they come with risks, such as market volatility and potential short-term losses.
*   Investing in equity funds involves understanding your financial goals and selecting funds that match your risk tolerance and investment philosophy.

![Equity Funds: Pooling money from investors to buy a portfolio of stocks](https://www.investopedia.com/thmb/DCUY1mMHTezheWMxCVVDBzTKTEc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/equityfund.asp-final-960d8955ad8b4576b85f3c803ce51e55.png)

*— Investopedia / Julie Bang*

## Exploring Different Types of Equity Funds

Equity funds each have their own investment strategy and management style. Two primary categories of equity funds are [actively managed funds and passive funds](https://www.investopedia.com/news/active-vs-passive-investing/).

### Comparing Active and Passive Equity Funds

*   **Actively managed**: These equity funds have portfolio managers who actively research, analyze and select stocks with the goal of outperforming a [benchmark](https://www.investopedia.com/terms/b/benchmark.asp) index, such as the S&P 500. They use their expertise and various strategies to decide whether to buy, hold, or sell stocks within the fund's portfolio. The success of an actively managed fund largely depends on the fund manager's skill and decision-making ability. Because of the more hands-on approach, actively managed funds typically charge higher fees than passive funds.
*   **Passively managed**: These include [index funds](https://www.investopedia.com/terms/i/indexfund.asp), which aim to replicate the performance of a specific market index. For example, an S&P 500 index fund seeks to mirror the returns of the S&P 500 by holding the same stocks in the same proportions as the index itself. Passive fund managers do not attempt to outperform the market; instead, they track the index as closely as possible. Because passive funds require less active management, they generally have lower fees and taxes than actively managed funds.

The choice between active and passive funds depends on your goals, risk tolerance, and investment philosophy. Some investors like the outperformance potential of active funds, while others prefer passive funds for lower costs and market-matching returns. Some funds offer a mix of the two to balance risk and potential returns.

> **Tip**
>
> Historically, passive funds have outperformed active funds, on average, after accounting for fees, transaction costs, and taxes.

### Understanding Equity Fund Market Capitalizations

[Market capitalization](https://www.investopedia.com/terms/m/marketcapitalization.asp), or market cap, is the total market value of a company's outstanding shares. Equity funds are often categorized based on the size of the companies they invest in. Companies with different sizes tend to have distinct characteristics and risk-return profiles.

*   **Large-cap funds**: These invest in stocks of companies with a large market capitalization, typically exceeding $10 billion, though this figure changes over time. These companies are usually well-established, mature businesses with a history of stable growth and consistent dividends. Large-cap funds are generally considered less volatile than funds investing in smaller companies, as large companies tend to have more stable revenues and greater financial resources to weather economic downturns.
*   **Midcap funds**: These put money into the stocks of companies with market capitalizations between large- and small-caps. These companies are often in the growth phase of their life cycle, with the potential for rapid expansion and market share gains. Midcap stocks may offer higher growth potential than large-cap stocks but also carry somewhat more risk.
*   **Small-cap funds**: These buy the stocks of companies with a small market capitalization, typically under $2 billion. These companies are often younger, less established businesses with the potential for high growth. Small-cap stocks can be more volatile and less liquid than their larger counterparts, but they may offer investors the potential for higher returns.

### Growth vs. Value: Choosing Your Equity Fund Strategy

Equity funds are also classified based on their investment strategy, with two main categories being growth funds and value funds:

*   [**Growth funds**](https://www.investopedia.com/terms/g/growthfund.asp) invest in stocks of companies expected to have more rapid earnings growth, often characterized by higher price-to-earnings (P/E) ratios. These companies usually reinvest earnings to grow the business, instead of paying dividends. Growth fund managers try to identify companies with new products, services, or business models that have the potential to disrupt their industries and capture significant market share.
*   [**Value funds**](https://www.investopedia.com/terms/v/valuefund.asp): These buy stocks that are considered undervalued based on fundamental analysis and often have lower P/E ratios, higher dividends, and lower price-to-book ratios. Value investors want to buy shares in companies trading at a discount to their intrinsic value, often because of temporary setbacks or market inefficiencies. These companies may be in mature industries with slower growth prospects, but offer the potential for steady returns and income.

> **Fast Fact**
>
> Blend equity funds invest in a mix of both growth and value stocks, aiming to provide investors with a balance between the two investment strategies.

### Sector and Geographic Specialization in Equity Funds

Equity funds are categorized based on their focus on specific sectors or geographic regions.

*   [**Sector funds**](https://www.investopedia.com/terms/s/sectorfund.asp) invest in the stocks of companies operating within a particular industry or market sector. Examples include technology, health care, financial, real estate, energy, and utility funds. Sector funds allow you to concentrate your exposure to a specific area of the market, which can be worthwhile if you have a firm conviction in an industry's growth prospects. However, sector funds are less diversified than broad-market funds and can be more volatile since they are tied to the performance of a single sector.
*   **Geographically focused funds**: Also known as [regional funds](https://www.investopedia.com/terms/r/regionalfund.asp), these buy the stocks of companies based in certain areas of the world. Domestic funds invest primarily in stocks of companies based in the investor's home country, while international funds buy stocks from companies primarily outside the investor's home country. Global funds invest in stocks of companies worldwide, including both domestic and international stocks. Emerging market funds invest in companies' stocks in developing economies such as China, India, or Brazil. Geographically focused funds allow investors to diversify their portfolios and carry unique risks, such as currency fluctuations, political instability, and differences in accounting and regulatory standards.

## Weighing the Benefits and Risks of Equity Fund Investments

Investing in equity funds offers several potential benefits to investors, including the opportunity for attractive returns, diversification, and professional management. However, it's essential to understand the risks associated with equity fund investing to make informed decisions and align investments with individual financial goals and risk tolerance.

### What Are the Potential Benefits of Equity Funds?

Historically, stocks have given investors the potential for higher returns than other asset classes, such as bonds and cash. From 1928 through 2023, the [S&P 500](https://www.investopedia.com/terms/s/sp500.asp), a broad measure of U.S. stock market performance, delivered an average annual total return of about 11.67% compared with 6.95% for investment-grade corporate bonds. Below, we provide a chart and table for rates of real returns over time for the S&P 500 versus 10-year Treasurys, real estate, investment-grade corporate bonds, and gold. While there have been, at times, steep drops in equities, it's typically ahead for more years than these other assets. Their long-term growth potential makes equity funds attractive to those wanting to build wealth over time.  

![Annual Real Rates of Return for S&P 500, 10-Year Treasurys, and Real Estate.](https://www.investopedia.com/thmb/fyWQ5mDkAucbAJjCOu_wYxE1LeI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/April9-8b96ae39677c4541b90e58eecb7467ce.png)

*— Investopedia*

A major benefit of investing in equity funds is [diversification](https://www.investopedia.com/terms/d/diversification.asp), 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.

If one stock you own drops in value, your investment is at risk. But with an equity fund holding many stocks, any drop in one has less effect on the overall performance.

> **Important**
>
> 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.

### What Are the Potential Risks of Equity Funds?

While equity funds offer prospects for attractive returns, they also come with risks to consider. The main one with equity funds is [market risk](https://www.investopedia.com/terms/m/marketrisk.asp), 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.  
  
Manage risk by keeping a long-term view, regularly reviewing and rebalancing your portfolio, and aligning investments with your risk tolerance and 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.  

### Equity Fund Pros & Cons

Pros

*   Higher expected returns over the long-run
    
*   Diversification
    
*   Professional management
    

Cons

*   Higher volatility and risk of loss than bonds or cash
    
*   Active funds can have high management fees
    

### Navigating the 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](https://www.investopedia.com/ask/answers/101314/what-are-qualified-retirement-plan-types.asp), 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\. Determine Investment Objectives and Select the Fund Style

1\. Determine Your Investment Goals and Time Horizon: Consider what you aim to achieve with your investments, whether saving for retirement, education, or long-term wealth growth.   
2\. Assess Your Risk Tolerance: Evaluate how much market volatility and potential losses you're comfortable with in pursuit of higher returns.   
3\. Select the Right Fund Style: Based on your goals and risk tolerance, choose from actively managed funds, passive index funds, sector-specific funds, and others that align with your investment profile.

Time horizon is the length of time you plan to hold your investments before needing to access the funds. Risk tolerance refers to your ability and willingness to withstand market volatility and potential losses in pursuit of higher returns.

### 2\. Researching and Analyzing Potential Equity Funds

1\. Review the fund's [Prospectus](https://www.investopedia.com/terms/p/prospectus.asp): Examine this legal document for detailed information on the fund's investment objectives, strategies, risks, and fees.   
2\. Analyze Financial Reports: Check the fund's annual and quarterly reports for updates on performance, holdings, management style, and management decisions.   
3\. Leverage Financial News Platforms: Use resources like Morningstar, Yahoo! Finance, and _Investopedia_ to access fund data, ratings, and peer comparisons.

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, the annual fee shown as a percentage of managed assets. Higher expense ratios can significantly impact long-term returns, so comparing a fund's fees to those in the same category is essential.

> **Tip**
>
> Most brokerages have mutual fund screeners that help you narrow down the thousands of fund options available based on your criteria.

### 3\. Start Investing

1\. Open an Investment Account: Choose between opening an account directly with the fund company or using a brokerage firm.   
2\. Fund Your Account: Transfer money from a bank or another investment account to start buying shares.   
3\. Purchase Your Chosen Funds: Once your account is funded, buy shares in your selected equity funds, adhering to any minimum investment requirements.

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 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.

> **Fast Fact**
>
> Mutual fund trades happen once daily at the market close, priced at the fund's net asset value (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](https://www.investopedia.com/terms/u/unsystematicrisk.asp) 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](https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp) criteria into their choice of investments.

## What Was the First Equity Fund and Does It Still Exist?

The [first modern equity fund](https://www.investopedia.com/ask/answers/09/what-was-first-mutual-fund.asp) 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 a 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](https://www.investopedia.com/investing/biggest-mutual-funds/)) 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 are a strategic investment for individuals seeking diversification and potentially higher long-term returns compared to bonds or cash. These funds provide options tailored to various investment styles, including actively managed and passive funds, and they can focus on specific company sizes, growth versus value investing, or distinct sectors or geographic regions. However, they are subject to market volatility, which poses a risk to investors. To align equity fund investments with your financial objectives, carefully evaluate your risk tolerance, time horizon, and tax considerations. Engaging a financial advisor and conducting thorough research can enhance your investment strategy and offer a broader understanding of how equity funds can serve your financial goals.

> **Article Sources**
>
> 1.  Ed Moisson. “[The Economics of Fund Management](https://www.cambridge.org/core/books/economics-of-fund-management/BDC003722BE6B045A76F73B6E9676B17),” Pages 79–80, 87–92, 136–40. Agenda Press, 2024.
>     
> 2.  S&P Global. "[SPIVA U.S. Year-End 2023](https://www.spglobal.com/spdji/en/spiva/article/spiva-us/)."
>     
> 3.  Financial Industry Regulatory Authority. "[Market Cap Explained](https://www.finra.org/investors/insights/market-cap)."
>     
> 4.  H. Kent Baker, et al. "[The Savvy Investor's Guide to Building Wealth Through Traditional Investments](https://www.researchgate.net/publication/340680132_The_Savvy_Investor's_Guide_to_Building_Wealth_Through_Traditional_Investments)," Pages 41-42. Emerald Publishing Limited, 2020.
>     
> 5.  Ed Moisson. “[The Economics of Fund Management](https://www.cambridge.org/core/books/economics-of-fund-management/BDC003722BE6B045A76F73B6E9676B17),” Pages 61–6. Agenda Press, 2024.
>     
> 6.  NYU Stern Business School. "[Historical Returns on Stocks, Bonds and Bills: 1928-2023](https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html)."
>     
> 7.  Internal Revenue Service. “[Capital Gains and Losses](https://www.irs.gov/taxtopics/tc409).”
>     
> 8.  Ed Moisson. “[The Economics of Fund Management](https://www.cambridge.org/core/books/economics-of-fund-management/BDC003722BE6B045A76F73B6E9676B17),” Pages 70–71, 134–140, 206–207. Agenda Press, 2024.
>     
> 9.  U.S. Securities and Exchange Commission. “[Expense Ratio](https://www.investor.gov/introduction-investing/investing-basics/glossary/expense-ratio).”
>     
> 10.  Massachusetts Financial Services Company. "[MITTX: Massachusetts Investors Trust](https://www.mfs.com/en-us/individual-investor/product-strategies/mutual-funds/MITTX-massachusetts-investors-trust.html#tab-overview)."
>      
> 11.  Morningstar. "[VTSAX](https://www.morningstar.com/funds/xnas/vtsax/quote)."