Equity vs Debt Mutual Funds: Difference and Which is Better?

Equity and debt funds are the two most popular fund schemes offered by mutual fund houses and asset management companies. Choosing the right one as per your investment perspective is important to meet your financial goals. But how can you decide which one is better for you or choosing the best one is one of the most challenging tasks for investors?

If you want to make the right decision between choosing both of them, you need to know how both mutual fund schemes are different from each other. On the basis of the key differences, you can decide which is better for you and suits your investment goals and risk profile. However, before we proceed on difference let’s find out the meaning and definition of equity and debt mutual funds.

Equity and Debt Fund – Meaning

Equity funds are the investable funds created by mutual fund companies, with the major portion of the corpus invested in equities or stocks and a small portion in debts and bonds. Derivatives like futures and options are also included in the equity funds.

While in debt funds, fund houses create the corpus mostly invested in the debt securities like government bonds, corporate debt, certificate of deposits, treasury bills, convertible debentures and other fixed-income securities that can give stable returns.

What are Equity Mutual Funds?

Equity mutual funds are investable mutual fund schemes in which two-thirds of assets are stocks. These funds are usually offered through open-ended funds providing long-term investable opportunities to investors with the potential to get good returns. However investing in equity mutual funds is risky, hence it is designed for high-risk investors.

These types of funds are created through market capitalization of companies or sector-wise. In equity mutual funds, you can pick from large-cap, mid-cap and small-cap funds created based on the corpus of funds used to invest in different types and sizes of companies. While investing in equity mutual funds you can get lucrative returns in the long run, but in the short run, the return could be affected by the market volatility but can add to your wealth creation.

What are Debt Mutual Funds?

In debt mutual funds, mostly bonds and debt-based securities are included which gives low but stable returns even in the short run. The popular investable instruments in debt funds are commercial papers, government bonds, corporate bills, certificates of deposits, and other fixed-income securities that have a shorter maturity life with low-risk factors.

Debt mutual funds are created by the fund houses for the investors to get stable and more secure returns that are free from market fluctuations. The duration of debts and securities in debt mutual funds could be from three months to 5 to 7 years depending on the maturity of the funds. Shorter-period funds don’t have interest risks, while medium- to long-term funds can be affected by medium to long-term interest rate risks.

Difference Between Debt and Equity Mutual Funds

Understanding the difference between debt mutual funds and equity mutual funds is very important to make the right decision for investing as per their risk profile and time horizon. You can find the key differences highlighted in the table below.

Equity vs Debt Mutual Funds: Difference

Aspects	Equity Mutual Funds	Debt Mutual Funds
Corpus of Funds	The main corpus of funds is invested in equities or stocks including derivatives with a small portion of the fund invested in other securities.	In this type of fund, major portion of funds is invested in debt securities like bonds and fixed-income securities giving stable and low-risk returns.
Securities in Funds	This fund is created by investing in underlying securities like equities, stocks, futures and options.	Debt-based securities, government or corporate bonds and fixed-income securities are included.
Types of Funds	Equity link saving schemes, large-cap funds, mid-cap funds, small-cap funds, flexi-cap funds, and focused funds are the major portion of funds.	Liquid funds, gilt funds, money market funds, overnight funds and other fixed-income securities are the part of debt mutual funds scheme.
Investment Goals	This type of fund is suitable for investors having long-term investment goals with the motive to generate capital with long-term capital gain.	Investors having medium to short-term investment goals seeking a stable return at low risk can invest in such with the motive to protect their capital.
Risk of Investing	Investing in such funds is riskier due to various factors like economic activities, inflation and market volatility can cause fluctuations in the value of the securities they contain.	Investing in these types of mutual funds is moderately less risky as the returns on such securities included in this fund can be affected by interest rate changes.
Impact of Volatility	The performance of these types of funds can be impacted by the volatility in the market.	These funds have a moderate effect of volatility in interest rates or the money market.
Potential of Returns	These types of funds have the potential to give high returns in the long-term time horizon.	There is low potential of giving returns to investors on investing in such types of funds.
Time Horizon	The time horizon of investing in such funds is usually more than 5 years suitable for long-term perspective investors to get good returns.	Suitable for short-term investors and its time horizon is typically less than 3 years or in months can give lower but steady returns at low risk.
Tax Liabilities	Investing in these types of funds, you have to pay tax on short-term capital gain if you sell your investment in profit within one year. If you liquidate your fund’s profitability in more than one year, it will be taxed under long-term capital gain.	The profits or income earned investing in these funds are taxed STCG if you sell within 2 years, while you sell your investment after 2 years and earn profit it will be considered as LTCG for taxation.
Tax Deductions	As per the latest updates, if you invest through Equity Linked Savings Scheme (ELSS) in mutual funds, you can claim up to Rs 1.5 lakh of tax deduction in a financial year.	While there is, no such deductions or tax benefit is available while investing in such funds.

 Debt or Equity Mutual Funds, Which is Better?

It becomes challenging to choose the right type of fund if you are not aware of the key differences between these type types of funds. If you have gone through this article, it becomes easier to pick the right one to invest as per your investment objectives. However, while choosing the right type of mutual funds you can consider the factors illustrated below.

Duration: If you have a long-term investment perspective, you can choose to invest in equity-related mutual funds. If your investment objective is short-term, you should choose these types of funds that have a shorter maturity life.

Lock-in Period: Equity mutual funds usually have lock-in periods of three years or more if there are no such lock-in periods in debt mutual funds or can be fixed dates with short duration.  

Risk Factors: Investing in equity-oriented mutual funds is riskier than debt funds as it can be affected by many factors mainly market volatility. While investing in debt mutual funds are less risky due to low but stable returns and can be affected only by interest rates.

Returns: If you invest in equity mutual funds, you can get high returns but when you hold your investment for the long term. While in debt funds, you will get lower but steady returns in the short term with a fixed maturity period and fixed income amount.

Taxability: If you invest in equity mutual funds STCG and LTCG are applicable on investments done for 12 months and more than 12 months respectively. In debt funds earlier the tax liability is applicable on more than three years of holding, which is now twelve months or more with STCG and LTCG.

Conclusion

You can choose the right mutual funds as per your investment goals, risk tolerance, time horizon and return perspectives. The equity-linked mutual funds are risky compared to debt mutual funds but can give you high returns if you hold your investment for the long term. On the other hand, a debt mutual fund is less risky but gives lower returns with stability.

The debt funds have shorter maturity periods with capital gain protection. However, investing in both types of funds with balanced investment can give you the benefit of both types of funds. Hence, you can choose the hybrid funds having a corpus of both equities and debts giving you the advantage of investing in both types of funds in a single scheme.

• Author: Religare Broking
• Last Updated: December 4, 2024