Equity and debt are the two most popular types of mutual funds. But how are they different from each other? Five of their most significant differences are discussed in this post.
One reason mutual funds in India have gained such immense popularity is the extensive availability of investment solutions. There are schemes for everyone, whether you're an aggressive long-term investor or risk-averse with a shorter horizon.
But in the mutual fund universe, the two most popular types of schemes are equity and debt. Let’s take a detailed look at these schemes and know the biggest equity VS debt funds differences to help you make informed investment decisions-
What are Equity Funds?
Equity funds are schemes that-
Mainly invest in equity and related instruments (at least 65% of the portfolio)
Seek long-term capital appreciation
Could be volatile in the short-term
Are ideal for investors with a longer investment horizon and a higher risk appetite
Primarily, equity mutual funds seek long-term growth. However, there are also some equity schemes that capitalize on specific market sectors and can have a different investment style.
Also Read – What Are Equity Funds?
What are Debt Funds?
Debt funds or income funds are schemes that-
Mainly invest in short-term and long-term debt securities like bonds, treasury bills, etc. (portfolio allocation into equities is less than 65%)
Invest in securities issued by public financial institutions, government, and companies
Have the potential to preserve capital and generate some income
Debt mutual funds can be categorized depending on the maturity of securities added to the scheme portfolio and/or security issuer or scheme management strategies.
Also Read – What Are Debt Funds?
Difference Between Equity and Debt Mutual Funds
Here are 5 of the biggest equity funds vs debt funds differences-
Portfolio Constituents
Equity Funds- As the schemes aim for long-term wealth creation, the portfolio is made up of equity and related instruments such as stock derivatives.
Debt Funds- Debt funds have a dual objective of capital preservation and income generation. These schemes invest in money market instruments, such as treasury bills, bonds, CDs (Certificate of Deposits), commercial papers, G-Secs (Government Securities), and NCDs (Non-Convertible Debentures).
Investment Risk
Equity Funds- Investment risk and returns are directly related. As equity funds focus on generating higher returns, they also come with a higher level of risk which can vary between different types of equity schemes.
Debt Funds- As capital preservation is a vital objective in debt schemes, between equity vs debt mutual funds, the latter has low to moderate risk.
Return on Investment
Equity Funds- Equity mutual funds could deliver potentially higher returns in the long run when compared to debt funds.
Debt Funds- The returns are usually low to moderate compared to equity mutual funds.
Taxation
Equity Funds- In equity funds, Long-Term Capital Gains (LTCG) are gains generated by holding the investment for 12 months or more. You generate STCG if the investment is redeemed within 12 months of investment.
LTCG from equity funds is taxed at 10%. However, LTCG gains of up to Rs. 1 lakh are tax-free. As for STCG, the gains are taxed at 15%. This is subject to STT (Securities Transaction Tax) without indexation.
Debt Funds- In debt funds, Long-Term Capital Gains (LTCG) are gains generated by holding the investment for 36 months or more. You generate Short-term Capital Gains (STCG ) if the investment is redeemed within 36 months of investment.
LTCG from debt funds is taxed at 20% with the indexation benefit. Short-Term Captial Gains from such investments are added to the investor’s taxable income and taxed as per their tax slab.
Read more about -
A Guide to Income Tax Slab for FY 2022-23
What is STCG?
Short-term capital gains or STCG is a tax levied on the capital gains or profits you earn by selling an asset you held for a short period, i.e., less than 12 months.
Ideal for?
Equity Funds- Investors with moderate-to-high-risk appetites can consider investing in equity funds to achieve their long-term financial objectives.
Debt Funds-Investors with a shorter investment horizon looking for investments that could generate potentially higher returns than bank FDs and savings accounts can invest in debt funds.
Overview of Equity VS Debt Mutual Funds
Here is a table highlighting the difference between debt and equity fund-
Parameter |
Equity Funds |
Debt Funds |
Portfolio Constituents |
Equity and related instruments |
Money market instruments |
Investment Risk |
Moderately high to very high |
Low to moderate |
Return on Investment |
Potentially higher than debt funds |
Lower than equity funds |
Taxation |
- LTCG (investment held for 36 months or more) @ 20% with indexation benefit
- STCG (investment held for less than 36 months) added to the investor’s taxable income
|
- LTCG (investment held for 12 months or more) @ 10%
- LTCG up to Rs. 1 lakh tax-free
- STCG (investment held for less than 12 months) @ 15%
|
Points to Remember Before Investing in Equity Funds
Want to invest in equity funds? Make a note of these points-
Risk Appetite
The risk level can significantly vary even between equity schemes. For instance, a small-cap scheme is generally riskier than a large-cap or index scheme. So, check the risk profile of the scheme before investing.
Expense Ratio
Higher expense ratios could eat up your returns. Before investing, ensure the expense ratio of the scheme is in line with similar equity schemes.
Fund Manager
The performance of an equity scheme abundantly depends on the fund manager. So, try to know more about the fund manager, their experience, and investment style before investing.
Points to Remember Before Investing in Debt Funds
If you’d like to invest in a debt mutual fund, focus on these factors-
Maturity
You can find debt schemes with maturities ranging from 1 day to several years. So, analyze your investment horizon and choose a scheme accordingly.
Click here to read about - What are target maturity funds
Scheme Portfolio
Schemes with low-rated bonds generally promise higher potential returns. However, the risk of default is also the highest in such schemes. Therefore, check the fund portfolio carefully to ensure your selected scheme aligns with your risk profile.
Credit Quality
You can find the credit rating profile of the assets the scheme has invested in on the AMCs website. Investors should check the same to analyze the credit quality of the scheme better.
Also Read – How to Invest in Mutual funds?
Building Your Investment Portfolio with Equity and Debt Mutual Funds
Both equity and debt funds are excellent investment choices. But as there are considerable differences between the two, investors should choose carefully after thoroughly understanding what they are and how they work.
Alternatively, you can add top-rated equity and debt schemes to your portfolio to diversify your investment. You can consult an investment advisor who can assist you in building an investment portfolio with schemes that align with your objectives, risk appetite, and investment horizon.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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