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Equity vs Debt Mutual Funds

07 July 2022

Mutual funds are a great way to invest in the stock market. They provide diversification, which means that if you own a mutual fund and it does poorly, you won't lose as much money as if you own individual stocks. Mutual funds also offer higher returns than individual stocks, which means that you can make more money on your investment.

The two most prevalent types of mutual funds are Equity Mutual Funds and Debt Mutual Funds. Let us understand the difference between equity and debt funds here in detail.

Equity Mutual Funds Vs Debt Mutual Funds

Equity mutual funds are equity-oriented mutual funds that invest in shares, bonds, and other securities. Debt mutual funds invest primarily in debt securities such as government and corporate debt.

There are many advantages to investing in equity mutual funds over debt mutual funds. The main advantage is the potential for higher returns because of the higher risk involved in equity investments. In addition, the investment horizon is typically longer than that of a debt fund because equity funds tend to be more volatile than debt funds.

Equity Funds

Equity Mutual Funds are the most common mutual fund in India. They are also known as open-ended equity funds. Equity funds provide the investors with an opportunity to invest in listed and unlisted companies, which have equity shares that can be bought or sold at any time.

The returns on these funds are dependent on the performance of the underlying stock market indices as well as other factors like government policies and regulations. Equity funds usually invest in large companies with a high market capitalization (the market value of the company divided by its number of shares).

The main advantage of an equity fund is that it offers higher returns than debt funds because it invests in more mature companies. This makes it suitable for long-term investors who want to see their money grow over time while they are retired or not working full-time.

Typically, equity funds are known to generate better returns than term deposits or debt-based funds. There is an amount of risk associated with these funds since their performance depends on various market conditions. 

A Mutual Fund scheme is classified as an Equity Mutual Fund if it invests more than 60% (sixty per cent) of its total assets in the equity shares of different companies. The balance amount can be invested in money market instruments or debt securities as per the investment objective of the scheme.

Further, the fund manager can choose to invest in a growth-oriented or value-oriented manner and select companies according to his assessment of the investment generating maximum returns. 

Factors To Keep in Mind Before Investing in Equity Mutual Funds

When you're investing in equity mutual funds, there are a few factors you should keep in mind.

1) Size Of The Fund

The size of the fund is important because it is a reflection of how much money you can invest in it. You should consider the size of the fund if you want to invest a large amount of money. A small fund may not be able to offer you enough returns for your investment and this will result in poor returns over time.

2) Expense Ratio

The expense ratio is another important factor to consider when investing in equity mutual funds. The higher the expense ratio, the more fees you pay per unit of value invested. This means that you will have to spend more money on fees and this makes it difficult for investors to make profits every year as they are required to pay more fees than they received back in return.

3) Risk Reward Ratio

This factor should also be considered when investing in equity mutual funds since their risk-reward ratio determines how well they perform over time against other investments that offer similar returns with less risk attached to them.

A high-risk reward ratio means that an investment will have a high chance of losing money while offering little or no returns over time which could lead investors into believing that there is no point in investing at all.

Debt Funds

Debt Mutual Funds are a type of mutual fund, which invests in debt instruments such as bonds and notes, government securities, debentures, and treasury bills. This type of mutual fund offers fixed returns on your investment. They also pay a minimum return after deducting expenses from the total return generated by your portfolio.

Debt funds often have higher expenses than equity funds because they are more diversified and require periodic risk management systems. Considered to be less risky than equity investments, many investors with a lower risk tolerance prefer buying debt securities. However, debt investments offer lower returns as compared to equity investments.

Debt funds are highly recommended to investors with lower risk tolerance. Debt funds are also available for

  • Short-term investors (3-12 months) – Rather than keeping your funds in a regular savings account, you can invest in liquid funds which offer 7-9% returns. Also, you do not compromise on liquidity. 
  • Medium-term investors (3-5 years) – If you want to invest in a low-risk instrument for 3-5 years, the first thing that probably comes to mind is a bank fixed deposit. Investing in a dynamic bond fund for a similar tenure tends to offer better returns than FDs. Also, if you need monthly payouts (like interest in FDs), you can opt for a Monthly Income Plan. 

Factors To Keep in Mind Before Investing in Debt Mutual Funds

Here are a few factors you should keep in mind while choosing to invest in Debt Mutual Funds:

1) Expense ratio

An expense ratio is the total amount of fees you pay for a mutual fund. This can include both management fees and any additional expenses for things like operating costs and transaction fees.

2) Management Fee

A management fee is charged by the fund manager, who must be paid a certain percentage of your investment every year. If you choose to invest in a fund with an annual management fee, it will cost you more than a fund without such an arrangement, but it's worth it if you can find one that charges more but still provides good returns on your money.

3) Risk appetite

The risk appetite of an investor is measured by how much risk they are willing to take on to make more money. The higher the risk, the higher their potential return. If you have a high-risk tolerance then you may want to invest in funds with higher-than-average rates of return or low expense ratios rather than ones with lower rates of return or high fees.

Equity Fund Vs Debt Fund: Comparative Analysis

Following is a comparative analysis of equity vs debt funds:

 

Equity Funds

Debt Funds

Investments

Shares of companies traded in the stock market. Are known to generate better returns than term deposits or debt-based funds

Invest in securities that generate fixed income like treasury bills, corporate bonds, commercial papers, government securities, and many other money market instruments

Risks Involved

Moderately high to high risk-taking appetite

Low to moderate risk-taking appetite

Taxation

15% tax on its capital gains if you have held them for less than 12 months

Short-term capital gains if held for less than 36 months

Returns

Comparatively higher in the long term

Lower in comparison

Investment Horizon

Suitable for long-term goals

Suitable for both short and long-term goals

Tax Savings

Available by investing up to Rs 150,000 in a year

No such option is available

Conclusion

Debt funds are on the higher side of average returns when compared to other types of funds and provide an assured return. They are quite low in risk and hence are safest for those investors who want regular income even if the capital takes a blow.

On the other hand, equity mutual funds have given higher returns over the years and have a greater potential of providing better returns than debt funds, but it depends on whether you invest in front-loaded debt funds or otherwise. 

However, before comparing debt vs equity funds or investing in any fund you should take into consideration your risk appetite, investment horizon, and also your age as equity funds are not meant for every person as larger risk does not fit everyone's profile.

Disclaimer: The views expressed in this post are that of the author and not those of Groww.

Disclaimer

The stocks mentioned in this article are not recommendations. Please conduct your own research and due diligence before investing. Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.
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