Knowledge Base

Overview of Equity and Debt Mutual Funds

Overview of Equity and Debt Mutual Funds

Mutual funds may be considered as a mechanism to take exposure to the stock market. It offers an opportunity to invest in a diversified, professionally managed basket of securities. In this article, we will break down two of the commonly known categories of mutual funds - equity and debt funds. 

[1] When choosing between equity or debt funds, one of the primary differences lie in the risk involved, with equity being riskier than debt. However there may be a potential to earn higher returns with equity funds. Debt funds can be considered comparatively less riskier and can be used by an investor for overall portfolio diversification.

What are Equity Mutual Funds?

Definition of Equity Funds:
An equity fund is a mutual fund scheme that invests predominantly in equity and equity related instruments.

As per SEBI’s Circular on  Categorization and Rationalization of Mutual Fund Schemes, an equity mutual fund scheme must invest at least 65% of the scheme’s total assets in equity and equity related instruments as prescribed by SEBI. A few key things that may be considered before investing in Equity Mutual Funds:

  1. Volatility: Equity mutual funds are more volatile compared to debt mutual funds. They have a tendency to experience significant fluctuations over a short period of time.
  2. Higher Risks: As these funds invest in equity and equity related instruments, they are inherently riskier than debt mutual funds.
  3. Potential for Higher Returns: Equity mutual funds may provide higher returns since they have the potential to beat inflation over a long term.

What are Debt Mutual Funds?

Definition of Debt Funds
Debt Mutual Funds invest predominantly in debt instruments such as bonds, government securities, debentures, and treasury bills. These funds aim to provide investors with stable and low to moderate returns over time. This makes it an attractive option for those seeking to preserve capital while generating modest growth. Unlike equity funds, debt funds are less susceptible to market volatility and may offer somewhat of a predictable income stream. 

A few key things to consider before investing in Debt Mutual Funds

  • Stability: Debt mutual funds offer stability with lower volatility compared to equity funds. This appeals to risk-averse investors seeking consistent returns.
  • Risks: Although they are less riskier than equity funds, debt mutual funds face risks such as interest rate risk, credit risk , and liquidity risk etc. This may impact the value and liquidity of the investments.
  • Lower Returns: Debt mutual funds typically yield lower returns compared to equity mutual funds in the long term due to the nature of fixed-income securities.

Difference Between Debt and Equity Mutual Funds

Features

Equity Mutual Fund

Debt Mutual Fund

Instruments

Equity funds predominantly invest in equity and equity-related instruments 

Debt funds primarily invest in debt and money market instruments like commercial papers (CPs), Treasury bills (T-Bills), certificates of deposits (CDs), corporate bonds, and Government securities (G-Secs), among others. 

Return on Investment (ROI)

Returns may be relatively higher compared to debt funds in the long term.

Returns may be lower than equity funds. 

Risk Appetite

As mentioned in [1], the risk level can be high or very high.

As mentioned in [1], risk level can be low, low to moderate, moderate, or moderately high.

Suitability

Equity funds may be suited for long-term investments. These are ideal for investors with high-risk appetite and can help in reaching long-term financial goals.

Debt funds give you investment options from a day to many years. It is suitable for investors with lower to moderate risk appetite and may be used as an alternative to fixed deposits and savings bank accounts.

Taxation 

Capital gains from equity funds held for less than 12 months are taxed at 15%. 


Long-term capital gains (held for more than 12 months) of up to ₹ 1 lakh are exempt and are taxed at 10% thereafter. 

Capital gains from debt funds held for less than 36 months are taxed as per the income tax slab applicable to the investor. 


Long-term capital gains (held for more than 36 months) are taxed at 20% after allowing for indexation benefits. 

Tax Saving Options

You can save taxes by investing up to ₹ 1,50,000 in a year in Equity Linked Saving Scheme (ELSS)  mutual fund schemes Section 80C of the Income- tax Act, 1961.

There is currently no tax-saving option in debt funds.

Conclusion

Debt funds have comparatively lower risk than equity funds, presenting a secure choice for investors prioritizing stability. On the other hand, equity mutual funds have the potential to beat inflation in the long term, but this potential for increased gains is accompanied by higher risk. Therefore, when choosing between equity and debt funds, it's crucial to take into account factors such as your risk tolerance, investment timeline, and age of the Investor.

[1]: SEBI has categorized the risk levels for mutual fund schemes as mentioned below:
1. Low Risk
2. Low to moderate Risk
3. Moderate Risk
4. Moderately High Risk
5. High Risk
6. Very High Risk

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

Please note that this article or document 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 or document 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 in any manner. 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 or document.

Published on 16 May 2024

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