Mutual funds come in a variety of types, with equity funds and debt funds being the most popular ones. While debt funds invest in government bonds and securities, equity funds invest in shares of companies. Equity funds are generally considered moderate-to-high risk, while debt funds are considered low-risk. At the same time, debt funds may give you lower returns than equity funds.
Equity Mutual Funds
Equity funds can be of different types based on geography (domestic or international), theme/sector-based stocks, company size (large, mid-cap, small or micro), pattern of investment (active or passive), etc. Equity funds are high in risk levels as it is directly dependent on the unpredictable stock market. However, a diversified portfolio mitigates the risk of loss considerably. Equity funds are valued at Net Asset Value (NAV), which is the per-share price of the fund, which is published every day after closing of market. Equity funds give you high returns over the long term as most equity funds contain a mix of volatile and steady stocks. Though the risk levels are not directly proportional to returns, some high-risk stocks will give you higher profits.
Balanced Mutual Funds
Balanced funds or hybrid funds invest in both debt and equity funds. Most balanced funds invest in 65-80% equity funds and the remaining 20-35% debt funds. This way, they combine the risks and performance graph of both equity and debt funds. The returns in balanced funds may not be as high as equity funds, but they will also be able to weather market instabilities because of the steadiness of the debt portion of the fund.
Difference between Balanced Funds and Equity Funds
Balanced funds and equity funds are different in the following ways:
- Equity funds are more volatile than hybrid funds because of the higher portion of market-driven equity stocks. Hybrid funds are cushioned against huge market falls by the presence of debt instruments. For example, in the stock-market fall of 2011, balanced funds lost 16% of their value and equity diversified funds lost 23%. But in case of a bullish market, balanced funds generate lesser profits. For example, in the 2009 stock market hike, balanced funds grew 60%, while equity diversified funds rose 82%.
- Balanced funds are higher in risk than debt funds, but lower in risk than equity funds.
- Equity funds may give higher returns than hybrid funds because of the direct market link.
- Fund managers in an equity fund alter the mix of stocks they hold as per market changes. Fund managers in a balanced fund, on the other hand, may change not just the companies in the equity portion, but may also change the ratio of equity-to-debt within the portfolio.
- Balanced funds with more than 65% equity instruments are liable to be treated as an equity fund. This means that despite having a debt portion, balanced funds are at par with equity funds in terms of taxation. The tax rate applicable for equity funds is 15% on short-term capital gains and no tax for long-term equity funds. However, if a balanced fund has more than 35% debt portion, then the fund will be considered a debt fund and not equity fund.
Over the longer term, both equity funds and balanced funds generate similar profits, because in hybrid funds, the losses from equity stocks is balanced out against the secure gains from debt tools. Balanced funds may be more suitable for new investors who want to get a hang of the mutual funds market and earn a steady stream of money, but do not want to take a high risk right away. Equity funds are better for people who want moderate-to-high risk investment and aim for greater short-term profits.Â
