Mutual funds are one of the most sought-after and practical investment methods among Indians. They help investors grow their money. Investing in equity and debt funds allows you to gain exposure to the stock market while minimizing the risk.

I bet you, too, will invest in mutual funds if you are fully aware of their benefits. In this blog, we’ll understand the difference between the two major mutual fund categories: equity and debt funds.

At times, when you have a lump sum amount for investment, you might be confused while choosing between the two fund categories. You know what I mean. The primary difference between the two is the risk involved, with equity being riskier than debt. However, equity funds have a higher potential to earn better returns. Continue reading to further explore the difference between equity and debt funds.

What are Equity Funds?

The term equity signifies ownership in a company. Purchasing shares or equities makes you the partial owner of the company. Talking about equity funds, they allocate over 65% of their total assets to stocks as per the SEBI’s guideline. 

The key objective of investing in equity funds is capital appreciation in the long term. While they may provide growth opportunities, they are more volatile and riskier than debt funds. 

Wondering whether equity funds are suitable for you or not? As an investor, you need to have a high-risk appetite along with a longer investment horizon to invest in equity funds. Furthermore, equity funds are categorized differently but largely based on market capitalization segments that are large-cap, mid-cap, and small-cap. Now, let’s dive into the benefits of investing in equity funds.

Benefits of Investing in Equity Funds

• Investing in equity funds can yield better returns compared to other investment avenues if you can take risks.
• When you own companies’ equities, you have a stake in their profitability, growth, as well as loss. When the company’s valuations inflate, your investment value will also rise.
• At times, companies often pay dividends to their shareholders when they make profits.

What are Debt Funds?

Debt funds primarily invest in debt instruments like government securities, bonds, debentures, and treasury bills. Investing in these funds will help you to get low to moderate returns over time, but they are generally stable. 

If you are a conservative investor who wants to preserve their capital while seeking modest growth, debt funds are just for you. Dissimilar to equity funds, debt funds are less vulnerable to market fluctuations and work as a predictable income stream.

Talking about the difference, the main difference between them is that debt funds are less riskier than equity funds. Now, let’s dive deeper into the benefits of debt funds.

Benefits of debt funds

• Debt funds offer stable returns because they invest in such kinds of securities that offer regular interest payments.
• They are comparatively less risky.
• Choosing debt funds can help you diversify your portfolio and offer stability and balance to it.
• Easy liquidity is another big factor of debt funds, adding convenience to investors as they can purchase and sell their units effortlessly.

Major differences between equity and debt funds

Let’s learn about the key differences between equity and debt funds, as having their clear-cut understanding will help you make informed investment decisions. Let’s hop directly into the differences without any further ado. 

1. Risk reward profile

Equity funds are highly risky as they invest primarily in shares, but also offer higher returns in the long term. On the other hand, debt funds are less risky while potentially offering lower returns.

2. Investment horizon

Equity funds are well-suited to investors with longer investment horizons (usually more than 5 years) who can handle the crest and trough of the market. Debt funds are ideal for investors with a shorter investment tenure seeking stable returns.

3. Returns

If you look at history, equity funds have generated higher returns over the long run, but they might experience major short-term fluctuations. 

On the flip side, debt funds provide lower returns as compared to equity funds, but provide a steady income stream.

4. Expenses involved 

The expense ratio of equity funds is much higher than that of debt funds because it demands intensive research, and fund managers need to take action quickly based on multiple parameters. While debt fund managers do not need to be involved so actively, therefore a lower expense ratio.

5. Suitability

Equity funds are mainly suitable for long-term investors with a moderately high to high-risk appetite. They help you to fulfill your long-term life objectives. 

On the contrary, debt funds come with moderate risks and allow you to make investments starting from just 1 day to many years. Investors consider it as an alternative to fixed deposits and keeping money in savings accounts.

6. Instruments

Investment instruments of equity funds include stocks or equity-related assets such as futures or options, whereas debt instruments include non-convertible debentures, treasury bills, certificates of deposits, commercial papers, government securities, and corporate bonds.

7. Taxation

Earnings from equity funds held for less than 12 months are taxed at 15%. Long-term gains (held for more than 12 months) are taxed at 10% with indexation benefits. On the other hand, earnings from debt funds, whether held for the short term or long term, are taxed as per the income tax slab rate of the investor.

8. Tax-saving option

You can save taxes by investing in Equity Linked Saving Schemes or ELSS mutual funds by investing up to 1.5 Lakhs a year, while there is no option to save taxes with debt funds.

Conclusion

While wrapping up this blog, it can be said that both equity and debt funds provide distinct advantages and cater to different financial needs. While debt funds present a secure choice for investors prioritizing stability, equity funds have the potential to beat inflation in the long run with good margins, but come with accompanying risks. 

The decision between the two hinges on the individual’s financial goals, circumstances, and risk profile. However, you need a balance of both in your investments to build a well-rounded portfolio that can withstand the volatility of the market and still work in your favor. Also, review and rebalance your portfolio periodically ( usually twice a year) to make sure it aligns with your financial goals.

Also Read

Difference Between FD and SIP

Importance of Retirement Planning in India

Why multi-asset funds are your best bet amid market fluctuations?