Investors now have plenty of options to grow their money. In those, the top options have been debt and equity funds. Each has its advantages, disadvantages and place in a portfolio. In order to make the proper decision, you need to know how they work, what type of returns they provide and which is best for your financial goals.
What are Debt Funds?
Debt funds are mutual funds that generally invest in fixed income instruments such as bonds, treasury bills, government securities and corporate debentures. These funds loan money to companies or the government in return for recurring interest payments.
- Level of risk: Mostly Low to Moderate
- Expectation of return: Steady but lower than equity
- Best for: Conservative investors, retirees or near-term goals
What are Equity Funds?
They invest mainly in company stocks. The objective is to build wealth in the long run, as markets rise and companies generate higher profits.
- Risk level: High
- Return outlook: Potential for high return over the long run, with short-term volatility
- Best for: Buy-and-hold investors; beginners who value simplicity and young professionals with some risk tolerance.
Main Distinctions Between Debt and Equity Funds
1. Risk and Volatility
- Debt funds are little less risky as they also involve interest payments.
- Equity funds rise and fall with the stock market, and therefore are more risky.
2. Return Potential
- Debt funds offer steady but low growth.
- Equity funds can be wealth multipliers over time, but may have short-term losses.
3. Investment Horizon
- “If you have short- to medium-term goals like buying a car or funding education, debt funds are the best bet,” she said.
- Long-term goals such as retirement or wealth creation are a good fit for equity funds.
4. Taxation
- Debt funds: Taxed at slab rate for short-term (3 years). Long term gains are taxed at 20% with indexation.
- Equity funds: short term (< 1 year) would be taxed @15%. Beyond 1 year taxed at Long-term (gains in excess of ₹1 lakh) -10% gains.
5. Liquidity
Both debt and equity funds provide liquidity but markets could have a greater say on equity funds. Debt funds also typically give a smoother redemption.
Which Should You Choose?
The decision of whether to invest in debt or equity funds will be based on your risk appetite, investment horizon and financial objectives.
- If stability is what you’re after, opt for debt funds.
- If you are looking for growth, think about equity funds.
- If you want to cover your bets and invest in both with a balanced approach, hybrid funds are known for doing just that.
FAQs:
Q1. Are debt funds risk-free?
No. Debt funds are considered safer than equity funds, but they have credit risk and interest rate risk.
Q2. Can equity funds assure me of returns?
No, equity funds are market-linked and their returns are linked to the performance of stocks.
Q3. Should novices invest in equity or debt funds?
Some beginners can begin with a combination of the two as little or as much risk you are willing to take on.
Q4. Which fund is best for short-term goals?
For short term goals it’s better to use Debt funds as they are less volatile.
Q5. Which is the better fund for long-term wealth creation?
Equity funds are better for growth wealth over longer period.
