You might have heard about different fund options to invest in. Equity and debt mutual funds are two different mutual fund investment approaches that differ mainly based on their underlying assets.
Equity funds allocate your investments across company equities for a potentially higher return with higher risks. Whereas a debt fund allocates your money across safer fixed-income instruments for a stable but lower return than equity funds.
With the mutual fund sector rising in India, currently boasting 25.86 crore folios, choose between these two fund options based on their differences, your risk appetite, and other factors.
A Brief About Equity Mutual Funds
When you are exploring mutual funds, you must note that funds that allocate at least 65% of their assets across company equities are categorised as equity mutual funds. However, this allocation goes higher, as different types of equity fund options are available.
For example, large-cap mutual funds allocate 80% of their investments across the equities of the top 100 companies. While mid-cap invests 65% across companies ranking between 101 and 250. Small-cap funds invest 65% of assets in companies ranked between 251 and beyond.
Thus, the aim here is to capitalise on the potential growth of such company stocks and generate optimised returns for investors.
Definition of Debt Mutual Funds
Unlike equity funds, debt mutual funds resort to much safer investable assets such as fixed-income securities. They include bonds, treasury bills, commercial papers, certificates of deposits and other money market instruments.
Such funds invest 65% of their assets in fixed income securities (e.g. floater fund) and can go up to 80% (e.g., gilt funds). Also, there are fund options that usually predominantly invest in money market instruments.
Thus, the aim here is to bring a sense of stability with a probable steady income option for investors, as such assets are comparatively safer than equities.
Differences Between Equity and Debt Mutual Funds for Suitability
From the difference between Demat and trading account, you know that both play their roles in buying, selling and holding shares. You can use a Demat for maintaining a centralised track of your purchased funds, stocks, bonds, etc. The following are the key differences between equity and debt funds:
1. Composition of Portfolio
Equity funds that predominantly invest in company stocks aim for potential long-term growth by staying invested for 5 to 10 years. Debt funds, by focusing on fixed-income and money market securities, help maintain potential stability and capital preservation.
2. Expected Return
Being focused towards the growth of company stocks, generally the return on such investment is higher. Based on historical performance, returns from equity funds usually range between 10% to 12% or more. Conversely, due to being focused on safe investment instruments, annualised returns from debt funds are low and range between 8% to 9%.
3. Taxation Norms
Your potential gains from equity fund investments draw an STCG of 20% with cess if you sell units within a year. An LTCG of 12.5% applies after INR 1.25 lakh expansion on gains if you hold units for more than a year. However, the STCG on debt mutual funds and its LTCG apply as per your income tax slab rate.
Suitability of Funds Depending on the Differences
Suppose your primary goal is achieving long-term wealth creation. Also, if you have a moderate to high risk appetite, then equity funds might be a suitable option for you.
However, if you have a shorter investment duration with a lower risk appetite, a debt mutual fund might be effective. It typically provides you with a stable return without taking much risk over your investment horizon.
Conclusion
An equity mutual fund looks for potential growth opportunities by investing in company stocks with growth potential. Whereas debt funds invest in fixed-income securities and, with minimal risk, usually provide a stable return.