There are enough videos on YouTube to tell you how many different classes of mutual funds exist out there, and that each is different in its own right. For the purpose of this article, let’s just two of the most hotly debated mutual funds - equity and debt mutual funds. Equity mutual funds, as you know, are mutual funds that invest in the equity market (or the stock market). What what are debt funds, and what’s difference between equity and debt mutual funds?
Let’s start right at the beginning:
It is an investment instrument through which an asset management company pools money from different individual and institutional investors having common investment objectives and invests it in different stocks, bonds, etc., as per the scheme mandate.
Mutual Funds could be classified as below:
Investing primarily in shares of listed companies is either active or passive. An active fund manager researches companies from different sectors and invests in companies likely to outperform the index in the future. On the other hand, a passive fund invests in a basket of stocks mirroring a market index, e.g. NIFTY or Sensex, directly proportional to the index.
Based on market capitalisation composition, equity funds are grouped under the following heads:
If the table above was not enough, then here are some more reasons for considering
A fixed income or debt mutual fund scheme invests a significant portion of its portfolio in fixed-income securities like government securities (G-Sec), corporate bonds, and money-market instruments (e.g. Commercial Paper (CP), Certificate of Deposit (CD), etc.).
Depending on their maturity or duration profiles, credit quality, and type of instruments they invest in, the SEBI has divided debt mutual funds into 16 categories:
Why invest in Debt Mutual Funds?
So, you’ve learnt about both the types of mutual funds and both of them seem enticing, so why not compare both before for more clarity
I hope after reading this piece, your prejudices and doubts have been put to rest. Fi offers a wide selection of funds to choose from for all types of investors and can be done in a matter of minutes! If you’re still unclear about equity and debt mutual funds, it’s advised that you consult with a financial advisor to make an informed investment decision.
How do you decide whether to invest in debt or equity funds? Let’s understand the critical difference between debt and equity funds:
An equity mutual fund principally invests its assets in equities, i.e. listed stock market securities. Per SEBI Mutual Fund guidelines, an equity fund is mandatorily required to invest at least 65% of its assets in equities and equity-related instruments with a balance 0-3 to be utilized in debt or money market securities.
A debt fund, on the other hand, invests in fixed-income securities such as government securities, corporate bonds, certificate deposits and other money market instruments. Per Income Tax Act, any fund with less than 65% of its total assets invested in equities should be termed as a debt fund.
By and large equity fund remittances are relatively higher over long periods, whereas debt funds may provide returns in accordance with inflation or marginally higher than inflation. On a long-term average basis, returns for debt are in the region of 9% and equity in the range of 16%.
Be it income generation or wealth creation. Debt is recommended if the expectation is to create income through their investments because it provides more certainty of return. However, for growth and wealth creation, equities would be a better option depending on the investment duration and return expectation.
Investors should select the asset class based on the period at the end of which they will need the money, for example, 20 years. Debt funds are better for shorter durations, preferably five years or less. Equity funds should ideally be held for a duration longer than five years.
The variation of returns in debt is usually small, and therefore, a long-term average of 9% implies that actual returns would be in a band of 8-10%. It means that there is a high degree of certainty that investors would get returns near the long-term average. Capital loss risk is also very low.
Equity returns vary in a broad range resulting in a high risk of capital loss. However, the longer the holding period, the narrower the range of returns variation. The decision between equity and debt is fundamentally a decision between an almost certain 9% return and an uncertain 16% return.
Equity investments are highly tax efficient with zero tax for holdings greater than one year. Debt funds attract short-term capital gains tax before three years and long term capital gains with indexation after three years. For an investor investing for longer than three years, there is no difference in tax between equity & debt.