Mutual Funds are an organised form of investment by finance professionals, investment houses or asset management companies (AMC). When an AMC starts a mutual fund for specific instruments, it attracts investors who put in money on the mutual funds. This collected money is used to trade in different investment options as promised in the given mutual fund.
Mutual funds are of different kinds, and each type of mutual fund caters to a particular risk level. The most popular ones are equity mutual funds and debt mutual funds. In this article we will learn about the similarities and differences between the two.
Debt Mutual Funds
Debt funds comprise highly-rated fixed-income investment options such as government bonds and securities, RBI bonds, money market instruments and corporate deposits. The risk levels are very low in this type of mutual fund, because the instruments invested in are not volatile and have fixed returns. Debt funds are valued at Net Asset Value (NAV) – just like other mutual funds. The NAV is the price per share of the mutual fund, and is published on a daily basis. The change depends on the value of the instruments invested in. However, debt funds do not guarantee high returns. The profits would be enough to cover the fund management charges and leave you some to reinvest or take home.
Equity Mutual Funds
Equity funds invest mainly in stocks and shares of companies. This is further classified based on geography (domestic or international), company size, pattern of investment (active or passive), whether the stocks are chosen at random or are thematic/sector-based, etc. Equity funds are high-risk because of the inherent market volatility of stocks, though a diversified portfolio – in which you choose to invest in different stocks with different risk levels – will mitigate the risk considerably.
Equity funds are also valued at NAVs, but the periodic return values are what determine the profitability of an equity mutual fund. Equity funds are high-return if you have chosen high-value or steadily rising stocks. Returns on equity funds depends on the amount of risk you are ready to take with your stock portfolio, and the growth of the stocks in your portfolio.
Difference between Debt and Equity Funds
The points mentioned below are what makes debt and equity funds different from each other:
- Debt funds invest in secure investment vehicles such as government bonds and securities, while equity funds invest in company stocks.
- Debt funds are a very low-risk investment option while equity funds are high-risk because of stock market volatility.
- Debt funds usually generate low or fixed returns, while equity funds, if invested wisely, can generate high returns.
- There are little chances of loss in debt funds, while equity funds could run into losses in case any of the stocks invested in, crashes or gives negative returns consistently.
- Debt funds are considered as a short-term capital if they are held for less than 3 years, while equity funds are considered as a short-term capital if they are held for less than 12 months.
- Debt funds become long-term capital if owned for more than 3 years, while equity funds become long-term capital after 12 months of ownership.
- The tax on short-term capital gains on debt funds is as per the income tax slab you fall under, while that on equity funds is a flat 15%.
- The tax on long-term capital gains on debt funds is 20% with indexation and 10% without indexation, while you have to pay no tax on the sale of long-term equity funds.
As an investor, when you buy a mutual fund, your risk appetite and investment objective will determine whether you should go for a debt fund or an equity fund. Debt funds are recommended to people who are looking for their investments to give them a fixed income, while equity funds are suitable for people who aim for investment growth and wealth creation. While debt funds are good for shorter-term investments of up to 5 years, equity funds give better returns on longer-term investments of 5 to 7 years.Â
