Difference Between Equity Funds And Debt Funds
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A mutual fund provides various investment options for different risk appetites, tenures and financial goals. When categorized on the basis of the investment objective, equity and debt funds are two popular options for investors. But each comes with its set of benefits and limitations. Read on to understand the differences between equity and debt funds before deciding which fund to invest in.
Table of contents
- What are Equity Funds?
- What are Debt Funds?
- Equity Fund vs Debt Funds
- Should You Invest in Equity Mutual Funds?
- Should You Invest in Debt Mutual Funds?
- How to Invest in Equity and Debt Funds?
- Risks Associated with Investing in Equity and Debt Funds
- Things to Consider Before Investing in Debt and Equity Funds
- Final Word
- FAQs on Equity and Debt Funds
What are Equity Funds?
An equity fund predominantly invests in equity shares of different companies and equity-related instruments (options, futures, etc.). Since these funds primarily allocate the investment corpus to stocks, the performance of these schemes is impacted by price fluctuations in the stock market. The main objective of these mutual fund schemes is capital appreciation.
Equity funds are classified into different types, which include large-cap funds, mid-cap funds, ELSS funds, sectoral/thematic funds, value funds, etc.
What are Debt Funds?
Debt funds invest in the fund corpus in debt instruments. The underlying securities may comprise government bonds, non-convertible debentures, commercial papers, etc. Since these mutual fund schemes invest in fixed-income securities, they are immune from stock market fluctuations. Accordingly, debt funds are suitable for conservative investors seeking stable income.
Similar to equity funds, debt funds are classified into different categories, such as liquid funds, long-duration funds, short-duration funds, dynamic bond funds, gilt funds and more.
Also Read: Dynamic Bond Funds
Equity Fund vs Debt Funds
Since now you know what debt and equity funds are, let’s take a look at their differences.
| Features | Equity Funds | Debt Funds |
| Associated financial risk | High | Low to moderate |
| Potential return on Investment | High | Comparatively lower than equity funds |
| Expense Ratio | Higher expense ratio than debt funds | Lower expense ratio than equity funds |
| Suitability | Suitable for aggressive investors seeking higher returns than debt funds | Suitable for risk-averse investors seeking stable income |
| Investment Timing | Since the stock market is somewhat volatile and dynamic, the timing to buy and sell equity is crucial. | The time of buying and selling is not that important. The tenure of investment is vital in the case of debt funds. |
| Taxation | STCG (Short-Term Capital Gains – when holding period is below 12 months) – 15% LTCG (Long-Term Capital Gains – when holding period is above 12 months) – 10%LTCG of up to Rs.1 lakh are tax-free | Short-Term Capital Gains (when holding period is below 36 months) – according to the income tax slab Long-Term Capital Gains (when holding period is over 36 months) – 20% after indexation benefits |
| Tax Benefits | Tax benefits under Section 80C of the Income Tax Act, 1961 are not available in the case of debt funds | One can claim tax deductions of up to Rs.150,000 during a year by investing in ELSS funds |
Should You Invest in Equity Mutual Funds?
Equity mutual funds are one of the most popular investment options for investors who have a high-risk appetite. Here are some reasons why you should consider investing in equity mutual funds:
- Diversification
Individuals can diversify their investment portfolios by opting for equity mutual funds. These funds invest across different sectors in the stock market with the goal of generating maximum returns. Equity mutual funds spread out the invested corpus which acts as a stabiliser during times of market turbulence.
- Capital appreciation
Investing in equity funds can help individuals earn a significant amount of returns. These funds tend to offer higher chances of capital appreciation than hybrid or debt mutual funds because they invest in assets that have high growth potential. Therefore, individuals with a high-risk appetite can consider investing in equity mutual funds.
- Tax savings
You can save a decent amount of taxes every year if you make investments in equity mutual funds. Equity Linked Savings Scheme (ELSS) is a mutual fund scheme that offers investors the benefit of claiming tax deductions under section 80C of the IT Act. The maximum amount of deduction an investor can claim is Rs.1.5 lakh.
Moreover, Long-Term Capital Gains (LTCG) of up to Rs.1 lakh from ELSS funds do not incur any kind of tax.
- Long-term growth
Equity funds are ideal for investors who have a long-term investment horizon. Historically, these funds have offered overwhelming returns to investors who stayed for the long run and utilised the full growth potential of the stocks. Staying invested for the long term also mitigates the risk factor associated with equity mutual funds.
Should You Invest in Debt Mutual Funds?
Debt mutual funds predominantly invest in fixed income instruments such as corporate bonds, treasury bills, etc. You can consider investing in debt mutual funds because of the following reasons:
- Volatility
A debt mutual fund in your portfolio will reduce its overall volatility and provide a sense of stability. If you have a low-risk appetite and are looking to generate stable returns from your investments, you can consider investing in debt mutual funds.
- Return potential
Debt funds have a higher return potential than other investment options like fixed deposit accounts. Investors have a high chance of gaining significant capital appreciation on their investment over a medium to long-term horizon due to compounding effects.
How to Invest in Equity and Debt Funds?
The method of investment in any debt or equity fund is quite similar. You can invest in these mutual fund schemes either through an intermediary or opt for a direct plan with the fund house.
Here are the steps that one should follow to invest in equity or debt mutual funds:
Step 1: Visit the offline branch or online portal of the fund house or intermediary (broker, agent, etc.)
Step 2: Provide your personal and financial details to complete the KYC process. In the case of online applications, you are expected to upload copies of your documents.
Step 3: Select the kind of mutual fund scheme (equity or debt) in which you wish to invest in.
Step 4: Select the investment method, i.e., SIP or lump sum.
Step 5: After selecting the mode of investment, click on ‘Invest’ to start your investment journey.
Risks Associated with Investing in Equity and Debt Funds
First, let’s consider the risk factors associated with investing in an equity fund:
- Risk of losing money
Equity funds tend to be highly volatile, so investors always face the risk of losing their money. Aggressive market fluctuations have the potential to wipe out your entire investment.
- Price risk
Equity funds are guided by changes occurring in the prices of stocks in which the money is invested. Price fluctuations due to news or any event can affect the fund’s portfolio drastically.
- Liquidity risk
Equities or stocks are highly liquid, which means that they can be easily bought or sold on stock exchanges. However, the overall trading volume of a stock can hamper this liquidity. If the stock volume is high and there is no potential buyer, then there could be serious losses to the mutual fund portfolio due to declining prices.
So, what are the risks associated with debt mutual funds? Check the below points:
- Default or credit risk
Debt funds invest in certain fixed income instruments like bonds or debentures. If the manager invests in low-quality instruments, there is always a risk of default. If the company or organisation is not able to pay its obligation, then it can lead to serious losses for investors.
- Interest rate risk
Markets always have to deal with flexible interest rates as they keep on changing frequently. If the interest rates rise, it will lead to a fall in the price of securities, thus lowering the value of the portfolio and vice versa. This can result in investors suffering serious losses.
- Liquidity risk
The securities in which the fund manager invests their money have certain liquidity attached to them. However, this liquidity is not static, and it may change as per market conditions. If the liquidity of security reduces due to a tightening of liquidity scenario, the fund manager will have to sell the security at a higher discount leading to losses.
Also Read: What Is Expense Ratio In Mutual Funds & How It Is Calculated?
Things to Consider Before Investing in Debt and Equity Funds
Keep the following parameters in mind when choosing between equity and debt funds:
| NAV | Net Asset Value (NAV) is the market value (minus fund expenses) of all shares in a portfolio divided by the total number of units available. It determines gains and losses in a mutual fund. Whenever there is a rise in a fund’s profit, NAV increases without any change in total units. This determines that there is an income on the investment. |
| Entry Load | This refers to a fee that individuals may have to pay before investing in a mutual fund. It is a percentage added up to the pre-existing NAV during investment. |
| Expense Ratio | The expense ratio refers to a yearly fee that the fund houses levy on investors to cover the cost of operating the fund. |
| Exit Load | An investor has to pay a charge, called exit load, at the time of redemption. This fee varies from one fund to another. |
| Experience of the Fund Manager | In the case of active mutual funds, such as equity and debt funds, fund managers are actively involved in all investment decisions. Accordingly, the performance of the scheme depends on the skills and knowledge of fund managers. In that regard, it is essential to consider a fund manager’s experience when selecting a scheme. |
| Holdings | Holdings refer to the portfolio constituents. |
| Investment Mode | A mutual fund offers two investment modes – Lump sum and Systematic Investment Plan (SIP). By choosing the lump sum route, investors can allocate the entire amount at their disposal to a mutual fund scheme. Whereas, by opting for an SIP, individuals can invest a certain sum in a scheme at fixed intervals. |
| Past Returns | Return refers to the financial loss or gains on mutual fund investments. Make sure to check the past returns of the scheme to find out whether a fund has been able to fulfil the objective it was set up to fulfil. |
Final Word
Now that you are aware of the differences between equity and debt funds, you can Consider downloading the Navi app and start investing in any of the equity or debt schemes offered by the Asset Management Company (AMC). But, before you choose to part with your savings, make sure to take into account certain vital aspects, such as your investment objective, risk-bearing capacity and investment time horizon.
FAQs on Equity and Debt Funds
Ans: Large-cap funds are a sub-category of equity mutual funds that allocate at least 80% of the investment corpus to equity shares of the top 100 Indian companies with regard to market capitalisation. The Navi Large Cap Fund is an example of a large-cap fund.
The main reason to invest in mutual funds is that the returns are much higher than other securities and financial instruments like recurring deposits, fixed deposits, etc. An individual can also save taxes by investing in an equity-linked savings scheme (ELSS).
Ans: Gilt funds are a type of debt fund that predominantly invest the fund corpus in government-issued fixed income securities with different maturity periods. These mutual fund schemes bear minimal financial risk because the underlying securities are government-backed.
Ans: A lock-in period is a timeframe, starting from the investment date, within which investors of a fund cannot redeem their units. Among the different categories of open-ended equity and debt funds, ELSS funds are the only type that comes with a lock-in period. Individuals who invest in ELSS funds can redeem their units only after the completion of 3 years from the date of purchase.
Ans: Yes, Public Provident Fund (PPF) is a debt investment wherein the principal amount is given back after the maturity period, and the investors can earn assured returns. These financial instruments come with a lock-in period of 15 years and are associated with low financial risk.
Ans: When investors allocate their money to a mutual fund scheme directly via the fund house or online investment platforms, they invest via a direct plan. In other words, a direct plan is offered by asset management companies directly; investors do not have to allocate their funds via third-party agents (brokers/distributors).
Ans: If you want to invest your money for the long term, you should consider investing in equity mutual funds. These funds can bring substantial returns for investors who have an investment horizon of 5 to 7 years. Staying invested for the long run also mitigates the risks associated with market fluctuations.
Ans: The ideal mix always depends on the person’s risk appetite and investment goals. If the individual has a low-risk tolerance, he/she should have a higher allocation in debt funds than equity funds. On the other hand, if the investor is aggressive and wants to take a high risk for earning significant returns, he/she should consider investing in more equity funds than debt funds.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article 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. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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