What Is an Equity Fund?

Equity Fund Definition
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For those of you looking to learn more about equity funds, this brief overview is designed to help you understand the basics, as well as point you in a direction to learn more about the different types of funds and how they work.

What Is a Basic Equity Fund?

An equity fund is a type of mutual fund that has a mandate requiring the portfolio manager to invest the shareholders' cash in ownership of businesses, also called equities, such as common stocks of publicly traded companies. Equity funds can come in both the traditional mutual fund variety or as so-called ETFs, which is short for exchange-traded funds. The latter trade over the stock exchange throughout the day, just like individual shares of stock, whereas an ordinary mutual fund settles once per day, with buy and sell orders netted after-hours to calculate the net asset value, or NAV

The Different Types of Equity Funds

There are many different types of equity funds, including international equity funds, which invest in stocks outside of your home country; global equity funds, which invest all over the world including your home country; sector equity funds, which invest in individual areas of the economy such as technology firms or banks; and even market capitalization equity funds, which limit investments to micro-cap, small-cap, mid-cap, large-cap, or mega-cap companies.

One of the most famous types of equity funds is the index fund, which acts as "dumb money," investing in stocks that mirror an index such as the Dow Jones Industrial Average

Should You Invest in Equity Funds or Individual Stocks?

A major decision that each investor will need to face is whether or not they want to invest in equity funds or invest directly in stocks. In general, most people are going to get better results by dollar cost averaging into a low-cost equity fund over long periods of time, reinvesting their dividends, and riding the ups and downs of the stock market until they reach retirement.

This is backed up by numerous studies, including one done by Morningstar that showed the average stock investor earned only 2 percent to 3 percent on their money, while at the same time, their underlying stocks grew by 9 percent to 10 percent. Scared and over-active, the inexperienced jumped in and out of companies, missing the gains that come from being a long-term owner of a good business.

What Should an Investor Look for in an Equity Fund?

Two of the largest equity fund companies on the planet are Fidelity and Vanguard, both of which offer a mix of actively managed funds, passive index funds, sector funds, bond funds, real estate funds, and almost anything else you can imagine. 

Generally, you are looking for an equity fund that:

  • has low costs, as measured by the expense ratio and lack of sales load
  • has little to no turnover in the underlying portfolio
  • matches up with your investing strategy or philosophy
  • is broadly diversified
  • has portfolio managers that invest a majority of their net worth in the same assets alongside you, putting their money where their mouth is
  • has a clearly defined mission so that you understand the types of assets it acquires, the reason it acquires them, and the reason it sells them
  • has a history of steady portfolio management.

How to Get Started Investing in Equity Funds

Once you decide you want to invest in equity funds, check out the fund offerings at major providers, browse through the fund rankings at mutual fund giant Morningstar, and then, once you've narrowed down your list of potential investments, read the mutual fund prospectus and statement of additional information (SAI). These documents explain how the mutual fund plans on investing your money, how much money the fund portfolio manager has invested alongside you, and a host of other valuable information that can make reaching an informed decision easier.

From there, you may want to establish an automatic investment plan. This allows for money to be automatically withdrawn from a checking or savings account, with the proceeds used to buy shares of your selected equity fund. Many funds will allow you to invest with as little as $25 per week, especially if you opt to open a Roth IRA or Traditional IRA through which to hold your shares.