An Informative Guide on How Debt and Equity Mutual Funds Differ

When it comes to investing in mutual funds, choosing between debt funds and equity funds is like taking two different paths. Equity mutual funds focus on investing in stocks, bonds and other securities. In contrast, debt funds primarily invest in debt instruments like government and corporate bonds.

By understanding how these two differ, you can invest smartly, keeping your future financial goals and risk appetite in mind.

What is an Equity Mutual Fund

An equity mutual fund is a type of fund that invests in stocks of listed companies and other equity-linked instruments. These are also called open-ended equity funds. These can be classified into the following:

• Large-cap fund
• Mid-cap
• Small-cap
• Micro-cap
• Multi-cap funds 

According to the Securities and Exchange Board of India (SEBI) rules, at least 65% of the fund’s assets must be invested in listed equities. The returns from these funds are primarily influenced by how well the stock market performs. In addition, factors like government policies and regulations also affect the returns. 

Typically, equity funds focus on large or growing companies with a high market value, which is calculated by dividing the company’s total value by the number of shares it has.

What is a Debt Mutual Fund

A debt fund is a type of fund that invests in fixed-income securities such as:

• Government bonds
• Corporate bonds
• Certificates of deposit (CDs)
• Commercial papers
• Debentures

These investments are less volatile than stocks, making them a good choice for risk-averse investors. According to the Income Tax Act of 1961, any fund that invests more than 65% of its assets in debt securities is a debt mutual fund. Here are some classifications of debt funds:

• Overnight funds
• Liquid funds
• Ultra-short duration funds
• Short duration funds
• Medium duration funds
• Long duration funds

Debt funds can invest in both listed and unlisted debt instruments to benefit from price increases, which are reflected in the fund’s net asset value (NAV). The performance of debt funds is mainly influenced by changes in interest rates.

Difference Between Debt and Equity Mutual Funds

The following table can help you compare equity vs debt funds, helping you choose a suitable type: 

Basis of Difference	Debt Mutual Funds	Equity Mutual Funds
Meaning	Invest in fixed-income securities such as government securities, treasury bills, corporate bonds, commercial papers, and other money market instruments.	Invest in shares of companies traded on the stock market, generally offering higher returns compared to debt-based funds or term deposits.
Returns on Investment	Offers lower returns than debt funds in comparison, but they are more stable and predictable in nature.	Typically offer comparatively higher returns over the long term, driven by market growth.
Risks Involved	Suitable for investors with low to moderate risk tolerance, as these funds are more stable and less affected by market fluctuations.	Ideal for investors with moderate to high risk tolerance due to the chances of loss of capital during market volatility.
Investment Horizon	Suitable for both short-term and long-term investment goals, depending on the specific fund.	Best suited for long-term investment goals, typically 5 years or more.
Tax Savings	No tax-saving options are available as per the current taxation rules in India.	Tax-saving benefits are available by investing up to ₹1.5 lakhs per year under Section 80C of the Income Tax Act of 1961.

Which is Better: Equity or Debt Mutual Fund

Before comparing debt funds and equity funds or going ahead with one option, it’s essential to consider your investment goals, risk tolerance and the time frame for your investment. This will help you choose an ideal fund since there is no one-size-fits-all option when it comes to investing.

Equity funds tend to offer better returns compared to debt funds as long as you’re comfortable with taking higher risks. On the other hand, debt funds are a good choice if you prefer lower risk and are looking with stable growth. 

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FAQs On Equity Vs Debt Funds

Which is preferable: a debt fund or an equity fund?

Deciding between debt and equity funds mainly depends on your financial goals and how much risk you’re willing to take. Debt funds are a good choice if you have a lower risk tolerance and aim for stable and moderate returns. Equity funds are better suited for those aiming for long-term growth and who can handle more volatility.

Are debt funds safer than equity funds?

Yes, debt funds are comparatively safer since they invest in less volatile instruments. This minimises the chance of loss of capital, making them ideal for investors with lower risk appetites.

Is it possible to invest in both equity and debt mutual funds simultaneously?

Yes, there is no restriction on adding debt funds and equity funds in your investment portfolio at the same time. However, consider various factors like your risk tolerance, goals, investment horizon and other factors to make an informed choice.