What Is The Difference Between Debt Funds And Equity Funds
It is always good to save for a rainy day. However, this basic idea has evolved a lot over the ages. Today, the savings you make are for a lot more than just to protect yourself and your family from financial troubles due to contingencies. There are various insurance schemes available in the market to take care of such contingencies. In order to save for life goals, we seek various investment instruments wherein we not only invest our savings, but the invested savings earn returns, resulting in a double support to the growth of the wealth. Having chosen to invest in mutual funds, you would first have to understand the difference between equity and debt fund and then decide which one to invest in.
What are the differences between debt funds and equity funds?
Here are four major differences between debt and equity fund investment:
1. Fund nature
Debt funds invest the accumulated corpus in fixed-income securities such as corporate and government bonds, non-convertible debentures, and other instruments with high ratings.
In comparison, equity fund investments are made in stocks and related securities. Schemes with more than 65% exposure in equities are classified as equity funds.
In case of equity funds, as investments are made in stocks and related securities, these are considered as high-risk. The Net Asset Value (NAV) is related to market movements, which are affected by various factors like central bank policy, inflation, taxes, and currency fluctuations.
On the other hand, debt fund investments invest the corpus in high-rated fixed-income instruments. Therefore, the risks are lower when compared to equity funds. However, debt funds are subject to interest rate fluctuations and you must consider this factor before making an investment decision.
In case of investments in equity funds for a period more than 12 months, the returns are considered as Long-Term Capital Gains (LTCG) and are tax-free. However, if you exit your investment before this period, the capital gains are short-term. A flat rate of 15% is levied as the tax on Short-Term Capital Gains (STCG).
Debt funds held for more than three years are considered long-term and subject to 20% tax after indexation. In case of short-term debt fund investment, the returns are added to your total income and tax is as per the tax bracket applicable to you.
Equity funds come with a higher risk but have the potential to deliver greater returns during the longer period. During rising markets, your equity fund investments will deliver higher returns.
In comparison, debt funds deliver stable and guaranteed returns because the majority of the corpus is invested in fixed-income securities. Investing in debt funds in case of market volatility or downturn to earn stable returns is advisable.
Debt funds vs Equity funds – how to choose?
Debt funds are the ideal investment for those who are highly risk-averse. Given the low risk, the returns as well are lower and thus you would have to invest higher amounts to compensate for the low returns, in order to achieve your financial goal.
Equity funds, on the other hand, are high-risk, high-return investments when compared to debt funds. The investments herein earn better returns, thus allowing you to achieve your life goals better and sooner with lesser investment. The concern, however, is the higher risk involved.
Thus, to conclude, you need to understand the difference between equity and debt fund and keep in mind the below-listed aspects and then decide which of the two is the most suitable for your requirements and comfort levels.
- Investment tenure
- Lock-in period
- Risk involved
- Tax implications
- Earnings potential
Having chosen the right one for you, you would further need to select the fund manager to invest with. In order to make an informed decision, you need to carry out detailed research on the available fund manager and the performances of their funds. The proprietary ARQ investment engine in the Angel Bee mobile application helps you with this detailed analysis and provides recommendations that are free of human bias.
The technologically-advanced ARQ tool eases your investment research analysis by providing you with customized investment recommendations.