What Is an Equity Fund and How Does It Work?

What Is an Equity Fund?

Equity funds are investment vehicles that focus on purchasing stocks of publicly traded companies. When you invest in an equity fund, you're buying shares of the fund instead of individual stocks. Your money in the fund—along with investments from thousands of other shareholders—is then used to purchase a diversified collection of stocks.

Fund managers make decisions about which stocks to buy, sell and hold based on the fund's investment strategy and objectives. Some equity funds target specific sectors like technology or health care, while others invest broadly across different industries and company sizes.

Learn more: How to Start Investing

Types of Equity Funds

Equity funds typically fall into two main categories, including actively and passively managed funds. Here's how they differ:

• Actively managed funds: These funds employ professional fund managers who research and select stocks they believe will outperform the market. These managers frequently buy and sell holdings to capitalize on market opportunities.
• Passively managed funds: Often called index funds, these funds track a specific market index like the S&P 500. Rather than trying to beat the market, these funds aim to match the performance of their chosen benchmark by holding the same stocks in similar proportions.

Pros and Cons of Equity Funds

As with any investment, there are both advantages and disadvantages to investing in equity funds. Understanding the potential benefits and risks can help you shape your investment strategy.

Should You Invest in an Equity Fund?

Equity funds can be suitable for investors who want exposure to the stock market but prefer professional management and built-in diversification. They're particularly appropriate if you:

• Have a long-term investment horizon (typically five years or more)
• Can tolerate market volatility and potential short-term losses
• Want diversification without researching individual stocks
• Prefer a hands-off approach to investing
• Are investing for goals like retirement or wealth building

However, equity funds might not be right for you if you:

• Need your money within the next few years
• Can't handle seeing your investment value fluctuate
• Want complete control over your stock selections
• Are looking for guaranteed returns or capital preservation
• Have a very low risk tolerance

Consider your financial goals, time horizon and comfort with risk before investing. It's also wise to ensure you have an emergency fund and have paid off high-interest debt before investing in equity funds.

Learn more: What's the Difference Between Saving and Investing?

How to Invest in Equity Funds

If you've determined that equity funds are right for your portfolio, here are some steps you can take to include them:

1. Define your investment goals. Determine whether you're investing for retirement, wealth building or another specific objective, and establish your time horizon.
2. Assess your risk tolerance. Consider how much volatility you can handle and whether you prefer growth-focused or more conservative equity strategies.
3. Select a broker or platform. If you don't already have one, open an account with a reputable brokerage firm or investment platform that offers access to the funds you want.
4. Choose your account type. Decide whether to invest through a taxable brokerage account, individual retirement account (IRA) or employer-sponsored retirement plan like a 401(k).
5. Research fund options. Compare expense ratios, performance history, management style and investment focus across different equity funds.
6. Make your initial investment. Transfer money to your account and purchase shares of your chosen equity fund, ensuring you meet any minimum investment requirements.

Consider automating monthly investments to take advantage of dollar-cost averaging and build your position over time. Also, be sure to review your investments periodically and rebalance your portfolio as needed to maintain your desired asset allocation.

Alternatives to Equity Funds

If you're not sold on equity funds or you want to diversify your portfolio across more asset classes, here are some alternatives to consider:

• Individual stocks: Buying shares of specific companies gives you complete control over your holdings but requires more research and creates concentration risk.
• Target-date funds: These automatically adjust their asset allocation based on your expected retirement date, becoming more conservative as you age.
• Robo-advisors: Automated investment platforms create diversified portfolios using ETFs based on your risk tolerance and goals, typically at lower costs than actively managed funds.
• Bond funds: Fixed-income funds provide more stability than equity funds but generally offer lower long-term returns and may not keep pace with inflation.
• Balanced funds: These funds include a mix of assets—usually stocks and bonds—to provide a more balanced approach to risk.
• Real estate investment trusts (REITs): REITs provide exposure to real estate markets and can offer portfolio diversification beyond traditional stocks and bonds.

The Bottom Line

Equity funds offer a practical way to participate in stock market growth while benefiting from professional management and diversification. Whether you choose actively managed funds or low-cost index options, these investments can play a valuable role in building long-term wealth.

As you consider ways to diversify your portfolio, consider consulting with a financial advisor who can provide you with expert, personalized advice for your situation and goals.