Equity vs Debt Mutual Fund: Which one should you invest in?
Mutual funds can be defined as one of the best ways to put your money in stocks. They guarantee diversification; thereby if you own a mutual fund and it does badly, your loss is not that big as compared to owning individual stocks. Besides personal stocks, mutual funds likewise offer higher returns compared to individual stocks. The investor can earn high returns on the investments by this method.
However, the two basic types of mutual funds are debt and equity mutual funds. So, let’s explore these funds in detail.
What are Equity Funds?
The capital pooled by equity mutual funds is largely invested in stocks and shares of various firms. To put it simply, it makes stock investments on your behalf. A preference share or other equity-related instrument makes up more than 65% of the equity mutual fund’s portfolio.
What are Debt Mutual Funds?
Debt funds are debt instruments that buy debt securities issued by corporate-specific entities & governments. These debt or fixed-income securities are purchased from the investor to the extent of the pooled corpus. Such instruments include corporate bonds, debentures, government securities, and the likes of treasury bills, commercial papers, and certificates of deposits that find their main application in the money market.
Differences Between Equity and Debt Mutual Funds
Now that we have a basic understanding of both these funds, let’s explore their differences: –
1. Risk Level
The equity mutual funds are perceived as much riskier relative to debt mutual funds due to the equity market exposure. Earlier, throughout the text, it has been implied that stock prices can be unstable and turbulent; therefore, equity funds are more affected by market failures.
While debt mutual funds entail lower risk since they invest in fixed-income securities, which are characterised by a certain yield, equity funds proffer higher returns. Nonetheless, there exists some degree of danger while holding these types of securities if the issuers fail to pay the interest.
2. Return Potential
Mutual funds in equity are possibly the best option because they have the opportunity to offer higher returns compared to those in debt, and they have exposure to the stock market. Equity funds will provide the investor’s earnings in the form of dividends and capital gains.
On the other hand, only debt mutual funds feature a stable but less attractive rate of return compared to equity investment funds. Through these funds, the investment is made in fixed-income securities. Thus, the income opportunity is restricted to the payments made by the issuers in the form of interest.
3. Investment Horizon
Equity mutual funds, which tend to provide higher returns over a longer period, can be an ideal option for long-term investments. Because of their vulnerability to market occasional dips, investors can suffer temporary decreases in value but their returns will usually be higher over the long-term period.
Contrary to this, debt mutual funds can be better products for short- as well as medium-term investments. These funds may provide a stable return but would not be useful in the case of the long-term investment goal.
4. Fund Management
Equity and debt mutual funds also differ when it comes to the fund’s management; mutual funds require active management because the stock market is never at a standstill, and managers of funds have to think boldly when making strategic investment decisions based on the current market conditions.
While debt mutual funds are somewhat passive since they put money into fixed-income securities with predetermined rates of return, equity mutual funds are active and required to make tough decisions. That implies that fund managers do not have to keep changing their positions to show some savings in their time.
5. Tax Implications
In addition to the other aspects, equity and debt fund’s tax implication also vary. Most countries rank equity mutual funds as taxed higher than debt mutual funds unless they are exempted. This is mainly due to the fact that dividends that are earned from equities are specially treated as capital gains, which actually subject to capital gains tax.
A debt mutual fund, unlike the case of indexation, may offer tax benefits like indexation for longer investment periods. This has the effect of lowering the tax burden investors have to contend with.
The Bottom Line
Both equity and debt mutual funds contain a distinct set of investment opportunities, which are accompanied by pros and cons. In the end, the choice to invest in equity or debt mutual funds will come down to your risk tolerance, investment goals, and present (current) market conditions. We suggest that talking to a financial advisor before investing is better. Having the right information and an understanding of mutual funds, you can choose a portfolio that will be the foundation of your financial success.
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