Equity and debt mutual funds are the most common investment options for individuals looking to grow their wealth. While both offer unique benefits, the choice between the two options depends on your financial goals, investment horizon and risk tolerance. To help you make an informed decision, let us compare equity mutual funds vs debt mutual funds and see which option aligns with your investment objectives.
What Is an Equity Mutual Fund?
Equity funds are mutual funds that primarily invest in the stocks of various companies. By investing in an equity fund, you own a share of these companies. The objective is to build wealth over time as the companies expand and their stock prices rise with industry growth. Equity funds are classified based on market capitalisation, such as large-cap, mid-cap and small-cap categories. Since stock prices can fluctuate, equity funds carry a higher risk but also offer the potential for greater returns.
What Is a Debt Mutual Fund?
A debt fund is a type of mutual fund that focuses on fixed-income investments like corporate and government bonds, corporate debt instruments and money market securities. These funds aim to provide capital appreciation while maintaining stability. Also known as fixed-income or bond funds, debt funds are well-suited for you if you prefer steady income with minimal risk exposure.
What Is the Difference Between Equity Mutual Funds vs Debt Mutual Funds?
The following table shows the difference between equity and debt funds:
| Parameters | Equity Mutual Funds | Debt Mutual Funds |
| Instrument | Invests in stocks and equity-linked instruments, such as derivatives | Invest in instruments like money market securities, corporate bonds, certificates of deposit (CDs), commercial papers (CPs), government securities (G-Secs), non-convertible debentures (NCDs) and Treasury bills (T-Bills), among others |
| Return on Investment | Higher returns in the long run | Lower returns but a more stable income source |
| Risk Level | Higher risk | Low to moderate |
| Investment Horizon | Ideal for individuals with long-term goals who are able to handle market fluctuations | Ideal for individuals with short-term goals who prioritise stability and lower risk |
| Diversification | Equity mutual funds allocate investments across various stocks from different sectors, aiding in risk diversification. | Debt mutual funds allocate funds to a variety of fixed-income instruments, helping to minimise default risk. |
| Taxation | A 20% tax applies to holdings for less than one year, while a 12.5% tax is charged on profits over ₹1.25 lakh for investments held beyond one year | Gains are taxable as per the income slab rate |
| Tax Saving | You can save taxes by investing up to ₹1,50,000 annually in ELSS mutual funds. | These do not provide any tax-saving benefits. |
What Are the Benefits of Investing in Equity Mutual Funds?
Here are some crucial benefits of investing in equity mutual fund:
Cost-Efficiency
Equity funds are cost-effective because they allow you to invest in a range of companies with small amounts, without the need for large capital. Buying stocks in each company individually would be much more expensive. By pooling resources, equity funds offer you the opportunity to invest in multiple companies, providing you with greater diversification at a lower cost than if you were to invest individually.
Growth Potential
Equity mutual funds typically offer higher returns than savings accounts or bonds. The potential for growth can help you achieve your financial goals, whether it is saving for retirement or paying off a mortgage.
Diversification
By investing in a single equity mutual fund, you gain exposure to stocks from multiple companies across different industries, sometimes even hundreds. This internal diversification reduces your risk, as poor performance by one stock is less likely to impact the overall fund significantly.
Professional Management
Equity mutual funds are managed by experienced professionals who research and select stocks for the fund. This means you can benefit from their expertise without needing to pick individual stocks yourself.
Tax Advantages
Certain equity funds, like ELSS (Equity Linked Saving Schemes), offer tax benefits. These funds allow you to claim deductions under Section 80C of the Income Tax Act, helping you reduce your taxable income.
What Are the Benefits of Investing in Debt Mutual Funds?
Here are some benefits of investing in debt mutual funds:
Diverse Investment Options
It offers a wide range of choices, from short-term funds that provide regular and stable income to long-term funds that generate returns from interest and capital gains. These options cater to different risk appetites, with funds like overnight and liquid funds investing in low-risk debt products.
Access to Expert Management
By investing in debt funds, you can earn interest and capital gains, while gaining exposure to money markets and wholesale debt markets—areas that might not be easily accessible to individual investors.
Lower Portfolio Risk
Debt funds are generally less risky than equity funds, making them a stable addition to your investment portfolio. Allocating strategically to well-performing debt funds can reduce risk and enhance the stability of your overall investments. Tactical investments can also help you capitalise on short-term yield opportunities.
Liquidity
These types of funds are highly liquid and can be easily redeemed, typically within one or two working days. Unlike ELSS, they do not have a lock-in period, though some funds may charge a small exit load for early withdrawals. Generally, there are no penalties for redeeming your investment.
Suitable for Short-Term Goals
Debt mutual funds are ideal for investing surplus money and earning interest, especially if you have short-term goals or need an emergency fund. They generally offer higher returns than traditional bank deposits, making them a helpful tool for fulfilling immediate financial needs.
How to Choose Between Equity Mutual Funds and Debt Mutual Funds?
Choosing between equity and debt mutual funds can feel challenging, as both offer unique benefits and drawbacks. A clear understanding of these options is key to building effective mutual fund investment strategies.
Selecting the right option depends on various factors, which are mentioned below:
- Financial Goals
You must clearly understand your investment objectives. If you are aiming for long-term goals like retirement planning or your child’s education, equity funds could be the ideal option due to their potential for growth over time. However, if your focus is on short or medium-term targets, such as buying a car or planning a vacation, debt funds may align better with your needs.
- Risk Assessment
Understanding your comfort level with risk. If you are comfortable with market ups and downs and willing to accept potential losses for the chance of higher long-term growth, equity funds could be the right choice. On the other hand, if you prefer a more stable and low-risk option, debt funds are likely a better fit. They prioritise stability and predictable returns.
- Tax Implications
Understanding the tax treatment of your investments is essential when deciding between equity and debt funds. Equity mutual funds attract a 12.5% tax on long-term gains exceeding ₹1.25 lakh annually and a 20% tax on short-term gains. On the other hand, debt mutual funds tax long-term and short-term gains as per your slab.
Final WordSelecting between equity mutual funds vs debt mutual funds can feel overwhelming, given their distinct features and benefits. Thus, getting advice from a financial expert can simplify your decision-making process. With their help, you can build a portfolio tailored to your objectives and confidently navigate the investment journey.
Frequently Asked Questions
Debt funds are generally considered safer than equity funds because they invest in fixed-income instruments like bonds and government securities, which are less volatile.
Although debt funds are typically viewed as less risky than equity funds, they are not without risks. Risks such as interest rate fluctuations, credit risk and liquidity risk can influence the returns of debt funds.
You must opt for equity funds if you have a long-term investment goal and are comfortable with higher risk for the possibility of greater returns. Debt funds are better suited if you are looking for stability, consistent income, a shorter investment horizon or have a more conservative approach to risk.
