What Is an Equity Fund?

Equity Funds Explained

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An equity fund is a special type of mutual fund, index fund, or exchange-traded fund (ETF) that invests in common stocks, or equities, rather than bonds.

As a new investor, you may not have heard of equity funds, and learning about them should be at the start of your financial journey. Once you understand what they are, you will still have to sort through the thousands of available options to find the best fit for your portfolio. Learn some of the basics and you will be more informed about what you are seeing whenever you look at a mutual fund prospectus or speak with a registered investment advisor.

What Is an Equity Fund?

An equity fund is a type of mutual fund or private investment fund, such as a hedge fund, that buys ownership in businesses (hence the term "equity"), most often in the form of publicly traded common stock.

The common denominator with equity funds is the desire for fund management to find good opportunities to invest in businesses that will grow, throwing out ever-increasing gushers of profit for the owners. This is in contrast to a bond fund or fixed income fund, which uses shareholder money to make loans to companies or governments and collects interest income.  

Types of Equity Funds

Equity Funds Focused on Geography

  • International equity funds: Invest in stocks outside of the United States
  • Global equity funds: Invest in stocks around the world, including those in the United States. That said, these funds tend to favor foreign stocks by at least 80% of their overall portfolio weighting
  • Worldwide equity funds: Invest in stocks around the world without making distinctions between domestic and international assets, following wherever the portfolio manager or investment methodology dictates
  • Domestic equity funds: Invest in stocks solely in the home country of the investor and issuer. For most readers, this will be the United States

Equity Funds Focused on Market Capitalization

  • Mega-cap equity funds: Invest in stocks of the biggest companies in the world. These companies are behemoths worth hundreds of billions of dollars (e.g., Walmart or Berkshire Hathaway)
  • Large-cap equity funds: Invest in companies with a large market capitalization
  • Mid-cap equity funds: Invest in companies with a medium market capitalization
  • Small-cap equity funds: Invest in companies with a small market capitalization
  • Micro-cap equity funds: Invest in tiny publicly traded companies worth a few million, or tens of millions, of dollars in market capitalization

Equity Funds Focused on Investing Style

  • Private equity funds: Invest in privately held companies that do not trade on the stock market. They may set up a limited liability company, infuse millions or even billions of dollars into it, raise money by issuing bonds, and then acquire businesses management believes it can improve.
  • Equity income funds: Invest in ownership of businesses that pay a significant dividend, often measured by a history of dividend increases, absolute and relative dividend yield, and conservative dividend coverage ratios. These funds are designed to bring income to the investor rather than just capital growth.
  • Dividend growth funds: Invest in ownership of businesses with a record of increasing dividends per share at a much faster rate than the stock market as a whole. There are many different ways to make money with a dividend growth strategy. They sometimes beat their higher-yielding counterparts and can make wonderful buy-and-hold investments. Dividend growth funds are similar to equity income funds.
  • Index equity funds: Mimic an index, such as the Dow Jones Industrial Average or the S&P 500. Though not always true, index equity funds tend to have some of the lowest mutual fund expense ratios. Investors have been flocking to index funds in recent years due to these low costs and simplicity. They are often "passively managed" (i.e., there is no fund manager working to "beat the market"). Funds that do pick stocks or time the market are active funds.
  • Sector- or industry-specific equity funds: Track specific areas of the economy, such as industries or sectors. This can be appealing for those who want to invest their money in certain types of businesses, which may not be a bad idea since certain industries have disproportionately produced high returns for owners.
  • Value funds: Seek to buy undervalued stocks as deemed by fundamental analysis that accounts for, among other things, book value relative to share price and dividend yield.
  • Growth funds: Invest in stocks with high growth potential, such as those in the technology or biopharmaceutical sectors. These companies may have unfavorable fundamentals, but the hope is that the companies will grow into their figures and produce a higher-than-average rate of return for investors.

In addition, equity funds can be bought as both traditional mutual funds and as exchange-traded funds (ETFs). Some investors tend to favor one type over the other, but there are advantages and disadvantages to both, depending on how the mutual fund is structured and the investor's financial goals and circumstances.

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
  • Little to no turnover in the underlying portfolio
  • An investing strategy or philosophy that you agree with
  • A broadly diversified portfolio
  • Portfolio managers that invest a majority of their net worth in the same assets alongside you, putting their money where their mouth is
  • 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
  • A history of steady portfolio management

Equity Funds vs. 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.

Stock investors may only earn a small amount on their money, while at the same time, their underlying stocks may have grown by much more. Scared and over-active, inexperienced investors may jump in and out of companies, missing the gains that come from being a long-term owner of a good business.

How to Invest in Equity Funds

When you decide that investing in an equity fund is the route you want to take for your portfolio, you have several options that might make sense. You can:

  • Open an account directly with a mutual fund family, such as Vanguard or Fidelity
  • Buy shares of an equity mutual fund through a brokerage account
  • Buy shares of an equity mutual fund through your 401(k) or 403(b) plan at work
  • Open a Roth IRA or Traditional IRA at a brokerage firm and use it to buy shares of an equity mutual fund

Just as with regular mutual funds, publicly traded equity funds are required to distribute all dividend income and realized capital gains (if any) to shareholders each year. As a result, you have to look at your total return, not just the share price, which can be deceiving depending on the level of distributions made in any given time period.

Most brokerage firms and virtually all mutual fund companies will allow you to automatically reinvest any distributions, in whole or in part, into more shares of the fund, so you increase your total ownership over time.

The minimum investment amount to begin acquiring these funds varies, but in most cases (especially for retirement accounts), they can be as low as $5 with regular monthly withdrawals from your savings account or checking account of $50 or more to help you build your investment portfolio over time. If bought through a plain vanilla brokerage account, the minimum can be $1,000, $2,500, $5,000, $10,000, or $25,000. Institutional equity funds can have minimum investments of $1 million or even $10 million. There are also several ETFs that mimic equity mutual funds, but you can trade them from your own brokerage account, typically for very low fees.

The Bottom Line

Once you decide you want to invest in equity funds, check out the fund offerings at major providers, browse through the fund rankings, 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.