Equity vs Debt Mutual Funds: Know Key Differences, Risks, Returns and Taxation

For investors looking to invest wisely, understanding the key differences between equity mutual funds and debt mutual funds is crucial. These two popular investment options cater to different financial goals, risk appetites, and time horizons. Whether you’re aiming for long-term wealth creation or seeking safer, short-term returns, knowing how these funds operate will help you make informed decisions and align your investments with your financial aspirations.

In India, equity mutual funds and debt mutual funds differ primarily in terms of where they invest, the associated risks, and potential returns.

However, readers must note that mutual fund investments are subject to market risks. You must read the scheme-related documents carefully before investing.

What Is A Debt Mutual Fund?

Debt mutual funds are a type of mutual fund that primarily invests in fixed-income securities, such as bonds, government securities, corporate debt, and money market instruments. These funds aim to provide investors with regular income and capital preservation, making them generally less risky compared to equity mutual funds.

What Is An Equity Mutual Fund?

An equity mutual fund is an investment vehicle that pools money from multiple investors to primarily invest in stocks, aiming for capital appreciation over time. These funds typically allocate at least 65% of their assets to equities, with various types available, such as large-cap, mid-cap, small-cap, sector-specific, and index funds.

Here’s a comparison:

1. Investment Focus:

Equity Mutual Funds: Invest primarily in stocks or equities of companies. These funds aim for capital appreciation and long-term growth by taking positions in the stock market.

Debt Mutual Funds: Invest in fixed-income instruments like bonds, treasury bills, government securities, and corporate debt. These funds seek to provide regular income and capital preservation.

2. Risk:

Equity Mutual Funds: High risk, as the value of stocks fluctuates based on market conditions. Suitable for investors with a higher risk appetite and long-term investment goals.

Debt Mutual Funds: Lower risk compared to equity funds. The primary risks are interest rate risk and credit risk, but they tend to be more stable than equity funds.

3. Returns:

Equity Mutual Funds: Potential for higher returns over the long term, but they are more volatile. Historical data shows that equities often outperform other asset classes over a long horizon.

Debt Mutual Funds: Provide relatively stable but lower returns compared to equity funds. They are more suitable for conservative investors looking for steady income.

4. Investment Horizon:

Equity Mutual Funds: Best for long-term investments (5-10 years or more) due to their volatility.

Debt Mutual Funds: Suitable for short to medium-term goals (a few months to 3 years), depending on the type of debt fund.

5. Taxation:

Gains from equity mutual funds held for 12 months or less are classified as short-term capital gains (STCG). If the holding period exceeds 12 months, the gains are categorized as long-term capital gains (LTCG).

STCG: 20% (for holdings less than 1 year)

LTCG: 12.5% (on gains above Rs 1.25 lakh for holdings over 1 year)

For debt mutual fund investments, taxation will continue to apply at the investor’s slab rate, regardless of the holding period.

Gains from other mutual funds will be treated as short-term capital gains if the holding period is less than 24 months; those held for more than 24 months will be classified as long-term capital gains.

6. Types:

Equity Mutual Funds: Includes large-cap, mid-cap, small-cap, and sectoral funds.

Debt Mutual Funds: Includes liquid funds, short-term funds, long-term funds, gilt funds, and corporate bond funds.

7. Suitability:

Equity Mutual Funds: Ideal for investors with a long-term horizon and willingness to take on market volatility for potentially higher growth.

Debt Mutual Funds: Suitable for risk-averse investors seeking capital protection and moderate returns, or those with short-term investment horizons.

In summary, equity funds are growth-oriented with higher risks and returns, while debt funds are income-oriented with lower risks and relatively stable returns.

Disclaimer: The views and investment tips by experts in this digihunt.com report are their own and not those of the website or its management. Readers are advised to check with certified experts before making any investment decisions.