When it comes to investing, there are countless options available to choose from. Amongst these, mutual funds have proven to be a popular choice for both novice and experienced investors. A mutual fund is a financial vehicle that collects money from multiple investors with similar investment objectives. The funds collected are then invested in various securities, such as stocks, bonds, and debentures. The returns generated from these investments are distributed among the investors according to their initial contributions.
One of the many benefits extended by mutual funds is diversification of assets. By investing in various securities, mutual funds offer investors the opportunity to achieve better returns at lower risk. Investors can purchase units of a mutual fund, effectively investing in a portion of the equity fund’s portfolio. The income generated from the securities in the portfolio is distributed to investors as monetary compensation or as capital to reinvest in additional shares.
However, it is important to note that mutual fund returns are subject to market risks and are typically calculated over a specific period – usually one, five, or ten years – from the fund’s inception.
There are various mutual fund options available to choose from, such as equity funds, debt funds, money market mutual funds, and hybrid funds. Of these, two more popular options are equity funds and debt funds. Both types of funds have unique characteristics and are suitable for different investors. In this article, we will explore the features of equity funds and debt funds and the differences between them.
Equity funds
Equity funds invest primarily in the stocks of various companies. If 60% of the total assets of a mutual fund scheme is invested into the equity shares of different companies, it is referred to as an equity fund. The balance amount can be invested in money market instruments or debt securities, depending on the scheme’s investment objective. This is usually left to the fund manager’s discretion and based on the investor’s unique financial goals.
Also known as open-ended equity funds, the returns on these funds depend on how the stock market indices perform. Additionally, the performance of equity funds also depends on factors such as government rules and frameworks. Hence, there is an element of risk attached to equity funds.
One of the main advantages of equity funds is that they offer better returns than other types of mutual funds. This makes them ideal for long-term investors willing to wait and let their money grow over time.
Debt funds
Debt funds are a type of mutual funds that invests in debt instruments. This includes – but is not limited to – notes, bonds, treasury bills, certificates of deposits, and government securities. Alternatively referred to as fixed-income funds, these types of funds offer fixed returns on your investments.
Debt funds focus on creating a regular income flow, with some debt funds even providing investors a significant capital appreciation. They are not directly affected by market volatility. As a result, they are comparatively less risky, making them a perfect pick for investors with lower risk tolerance. Furthermore, when compared to equity funds, debt funds have a lower expense ratio. However, it is also important to note that debt investments also offer lower returns than equity investments.
While equity funds work best as a long-term investment option, debt funds are more versatile – they act as short-term and long-term investment tools based on the investor’s needs.
Differences between equity funds and debt funds
| Equity funds | Debt funds |
| Primarily focus on buying shares of companies with high market capitalization | 1. Focus on investing in debt and money market financial tools |
| Returns from equity funds are higher compared to debt funds | 2. Debt funds provide moderate returns |
| The risk factor involved ranges from moderately high to high risk | 3. Good for investors looking for low to moderate risk options |
| Equity funds are actively managed by fund managers. Hence, the expense ratio is higher | 4. Compared to equity funds, the expense ratio is lower in debt funds |
| They operate as a good long-term investment option | 5. They offer flexibility by performing as a short and long-term investment option |
| Equity funds are subject to 15% tax on capital gains if held for less than 12 months. Long-term capital gains are exempt from tax up to Rs 1 lakh. Post this, it is subject to a tax rate of 10%. | 6. Debt funds are subject to taxation if short-term capital gains are held for less than 36 months. Post this, long-term capital gains are subject to 20% tax rate, after availing of indexation benefits |
| Equity-linked savings funds offer tax savings up to Rs 150,000 per annum | 7. Debt funds do not provide tax benefits |
Equity funds vs Debt funds: What is the right choice for you?
There are several factors to consider when choosing between equity funds and debt funds.
Investment size: The amount of money you invest in any financial plan plays a vital role in the returns you draw. Before you invest a sizable amount, it’s crucial to ensure that the fund aligns with your financial health. Given that the risk is higher in equity funds, a significant investment can, no doubt, lead to great returns but also equally damaging losses.
Expenses: The expense ratio plays a significant role when choosing a mutual fund. This ratio refers to the operational and transactional charges paid for by the investor. They are usually collected from the returns generated. The higher the expense ratio, the more you spend on fund management fees. This invariably eats into your yearly profits. The expense ratio is traditionally higher in equity funds when compared to debt funds. Even in terms of taxation, equity fund and debt fund vary significantly.
Risk-reward ratio: The risk-reward ratio is critical in choosing any investment instrument. One of the basic tenets of finance is that risk and return go hand-in-hand – “”higher returns can be achieved by taking on higher risks””. But that’s not applicable all the time. Checkout this equity fund myth busters blog to know more!”
A high-risk investment brings with it the possibility of great returns and tremendous losses. This could discourage investors from investing. If you have an appetite for high-risk financial schemes, equity funds may be the way to go. Debt funds have proved to be a better option for more conservative investors.
Bottom line
Debt funds and equity funds are two types of mutual fund investment options with distinct characteristics and goals. It’s essential to understand the differences between these equity fund and debt fund and choose the one that aligns with your investment goals and risk tolerance. It is advisable to consult a financial advisor to understand which one aligns better with your portfolio.
Disclaimer: This blog has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The information/data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this blog are as on date. The blog does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
