Equity Mutual Funds Explained: Categories, Plans & Taxation in India

“Why Not Invest in the Top-Performing Fund?” — A Conversation We Hear Every Day

(Mutual Fund Series – Part 2)

An investor, Ravi, walks into the InvestAlly office.

Ravi: “I want to start investing. I have surplus income and don’t want it lying idle.”

The InvestAlly advisor begins with the basics — something most advisors/investors skip.

IA Advisor: “That’s great. Let’s first understand your financial goals, time horizon, and risk appetite.”

Ravi explains that he wants long-term wealth creation, can stay invested for 5–7 years, and is okay with some market volatility — but not extreme ups and downs.

The advisor nods and starts explaining how different equity mutual fund categories behave differently based on risk and time horizon.

Midway through the discussion, Ravi pulls out his phone.

Ravi: “But I already did some research. I Googled it.
This is the top-performing mutual fund of the year.
Every platform and ranking suggests this fund.
Why don’t we invest in this?”

The advisor pauses.

IA Advisor: “The fund may be a good performer, but the category it belongs to is not suitable for your risk appetite.”

Ravi laughs 😄

Ravi: “Wait… what? You’re telling me not to invest in the top-performing fund?
That doesn’t make sense.
What do you mean by ‘category’? Why is it not suitable?
Google, platform, rankings, investment apps, even AI tools recommend this fund.
Why are you saying no?”

This moment captures the most common investor mistake.

Because what Ravi didn’t know is this:

• Mutual fund returns come from funds’ performance
• But risk, volatility, and suitability come from the category mandate
• And choosing the wrong category can hurt your financial goals — even if the fund looks great on paper.

This blog exists to explain exactly what Ravi didn’t know — and it’s part of our ongoing Mutual Fund Series, designed to simplify investing decisions for real investors.

Why Mutual Fund Categories Matter More Than Fund Rankings

Most investors start with questions like:

• Which is the best mutual fund?
• Which fund gave the highest returns last year?
• Which fund is trending?

But very few ask:

• Is this fund category right for my goals?
• Does this category match my risk tolerance?
• How volatile is this category during market downturns?

Fund rankings often grab headlines, but understanding mutual fund categories is the bedrock of informed investing. It's about comparing apples to apples and making strategic choices based on your financial goals.

🎯 Targeted Investing: Categories help you choose funds that align with your risk appetite and investment horizon.

📊 Performance Benchmarking: Evaluate fund performance against its peers within the same category for a true picture.

🛡️ Risk Management: Diversify across categories to mitigate risk and build a resilient portfolio.

🧭 Goal Alignment: Select categories that match your specific financial objectives, be it growth, income, or tax savings.

Mutual fund categories are defined by SEBI to bring clarity, standardisation, and transparency. Each category has a clear mandate — what the fund must invest in and how much risk the fund manager can take.

Only after selecting the right category should an investor choose the best fund within that category.

Equity Mutual Fund Categories (As per SEBI / AMFI Guidelines)

Below is a simplified table of equity mutual fund categories and their mandates as defined by SEBI and followed by AMFI.

Important: Always read the Scheme Information Document (SID) to understand the detailed strategy, risks, and asset allocation of the fund you are investing in.

💡 Fun Fact: Did you know that an AMC is allowed to have only one mutual fund per SEBI-defined category?
Have you ever wondered that- Why You Don’t See Two Flexi Cap Funds or two Large Cap funds from the Same AMC.
This is because of SEBI rules- which restricts an Asset Management Company (AMC) from having two Mutual funds in the same category.

Why Did SEBI Introduce This Rule?
Earlier, AMCs launched multiple funds with similar portfolios but different names — creating confusion and mis-selling.

SEBI stepped in to ensure:
🛡️ No duplication of similar schemes
✅ Clear differentiation between categories
⚖️Easier comparison across AMCs
🔍Better transparency for investors

How This Helps Investors
🎯You know exactly what a category is supposed to do
⚖️You compare similar funds across fund houses
✅ You avoid investing in “look-alike” schemes
🚀Decision-making becomes simpler and more logical

In short: One AMC, one category — done right.

Types of Mutual Fund Plans: Growth vs IDCW (Income Distribution cum Capital Withdrawal)

Once the category is chosen, the next decision is selecting the type of plan.

Taxation of Equity Mutual Funds in India (Growth vs IDCW vs ELSS)

Understanding taxation is critical to avoid unpleasant surprises. Taxation plays a crucial role in determining your real investment returns.
Equity mutual funds are taxed differently based on the type of plan, holding period, and purpose of investment.
The table below gives a clear, side-by-side view of how Growth, IDCW, and ELSS funds are taxed at different stages.

📊Equity Mutual Fund Taxation – At a Glance (Post Budget 2024)

How to Read This Taxation Table

• On Investment
  There is no tax at the time of investing in equity mutual funds. Investments are always made using post-tax income.
  However, ELSS investments qualify for a tax deduction under Section 80C, which reduces your taxable income for that year. This applies only if you are filing your return under “Old regime”.
• Regular Payouts
  Applies only to IDCW plans. Any payout received is treated as income and taxed at your applicable income-tax slab rate.
• Redemption within 12 months
  Refers to situations where units are redeemed(sold) within one year of investment. Gains in this case are treated as short-term capital gains (STCG) and losses as short-term capital loss (STCL).
• Redemption after 12 months
  Applies when investments are redeemed(sold) after one year of investment. Gains qualify as long-term capital gains (LTCG) and losses as long-term capital loss (LTCL).
• Lock-in Period
  Indicates whether the investment can be redeemed freely or has a mandatory lock-in. This is particularly relevant for ELSS funds, which have a 3-year lock-in.

📌 Grandfathering Rule for Equity Mutual Fund Investments (Pre–31 January 2018)
When Long-Term Capital Gains (LTCG) tax on equity was reintroduced in 2018, the government ensured that investors were not taxed retrospectively on gains already earned.
This protection is known as the Grandfathering Rule, introduced under the Income Tax Act.

What Does the Grandfathering Rule Mean?
If you invested in equity mutual funds before 31 January 2018:
a. All gains accrued up to 31 January 2018 are permanently tax-free
b. Only the gains made after that date are subject to LTCG tax

In simple terms:
👉 You are taxed only on future appreciation, not on past gains.

Why This Matters for Long-Term Investors
a. Long-term equity investors are protected from retrospective taxation
b. Older investments continue to enjoy a tax advantage
c. Only incremental gains are taxed under current LTCG rules

Investor Takeaway
If you have been investing in equity mutual funds since before 2018,
your earlier discipline is rewarded — not penalised.
This is a crucial nuance many investors miss when calculating their actual tax liability.
To explore more common myths and facts around equity mutual fund taxation, stay tuned for our upcoming blog — “Tax Myths Investors Still Believe.”

Capital Gain Set-Off Rules (Quick Overview)

• Short-term capital loss can be set off against both STCG and LTCG
• Long-term capital loss can be set off only against LTCG
• Unutilised losses can be carried forward for up to 8 years (subject to timely filing of returns)

The Real Lesson from Ravi’s Story

Ravi wasn’t wrong to look at performance.
He was wrong to start with performance.

At InvestAlly, we believe:

⚠️ Beware of Hype: Don't be swayed by short-term performance or popular opinion.
✅ Understand Your Risk: Assess your risk tolerance and investment horizon before choosing funds.
📚 Educate Yourself: Take the time to understand the fundamentals of mutual fund investing.
🤝 Seek Advice: Consult with a financial advisor for personalized guidance.

That’s how investing becomes structured, stress-free, and aligned with your life — not just market rankings.

Final Thought

Fund rankings show recent winners, but lasting wealth comes from choosing the right mutual fund categories. Categories shape how a fund behaves and help you diversify your portfolio, instead of unknowingly taking the same risk again and again.

Before you invest, ask yourself:

“Do I understand what this fund is meant to do — and how it fits into my portfolio — not just what it did last year?”

If the answer isn’t a confident yes, don’t guess.
Seek guided, personalised advice that helps you diversify thoughtfully and align your investments with your life — not just market trends.

At InvestAlly, we believe investing should be clear, structured, and aligned with your life — not driven by noise or short-term rankings.