Equity & Debt Funds – Know the Difference Between Equity vs Debt Funds
When it comes to investing in mutual funds, an investor has various options. But, equity and debt funds are the two most popular investment options chosen by investors. This blog discusses equity & debt funds and the differences between them.
What are equity funds?
An equity fund is an open-ended mutual fund scheme that invests most of its assets in equity and equity-related instruments. From a taxation point of view, any fund that invests a minimum of 65% of its total assets in equity and equity-related instruments is classified as an equity fund.
An equity fund invests in equity shares of various companies. Based on market capitalisation and investment theme, equity funds can be further divided into the following twelve sub-categories:
- Multi-cap fund
- Flexi-cap fund
- Large-cap fund
- Mid-cap fund
- Large and mid-cap fund
- Small-cap fund
- Dividend yield fund
- Value fund
- Contra fund
- Focused fund
- Sectoral or thematic fund
- Equity-linked saving scheme (ELSS)
Why should you invest in equity mutual funds?
Equity mutual funds carry high risk and have the potential to give inflation-beating high returns. For example, the Nifty 50 Index was launched in April 1996 with a base value of 1,000. As of 31st December 2021, the index was trading at levels of around 17,000. During these 25 years, the index has multiplied 17 times, creating huge wealth for investors. Since its inception, the index has given an excellent return of 11.52% CAGR.
So, as an investor, if you want to create wealth for yourself in the long term, you should consider investing in equity mutual funds. They can play a key role in achieving your financial goals.
Diversification of equity mutual funds
Based on your requirement, you can choose to invest in various subcategories within the broader equity mutual fund category. Some of these funds include:
Market capitalisation: If you wish to invest in equity mutual funds based on market capitalisation, then you can choose from large-cap funds (invest in 1st – 100th companies by market capitalisation), mid-cap funds (invest in 101st – 250th companies by market capitalisation), or small-cap funds (invest in 251st – 500th companies by market capitalisation).
Across market capitalisation: If you wish to invest in an equity fund that gives you exposure to companies across market capitalisation, you can choose from a multi-cap fund (invests a minimum of 25% in each of large, mid, and small-cap stocks) or a flexi-cap fund (fund manager has the flexibility to invest in companies across market capitalisation).
- Sectoral or thematic funds: If you wish to invest in stocks belonging to a specific sector, you can choose to invest in a sectoral fund. Some examples include a banking fund, healthcare fund, IT fund, etc. If you wish to invest in stocks belonging to a specific theme, you can choose to invest in a thematic fund. Some examples include rural, ESG, digital theme funds, etc.
What are debt funds?
A debt fund is an open-ended fund that invests most of its assets in fixed-income securities such as Government securities, corporate bonds, etc. These funds are relatively less risky compared to equity funds. They have the potential to provide low to medium returns.
Difference between equity and debt fund
We have understood what an equity and debt fund is. Now let us understand the differences between these funds.
|Feature||Equity fund||Debt fund|
|Where do they invest||An equity fund invests most of its money in equity and equity-related instruments of various companies.||A debt fund invests most of its money in fixed income instruments such as Government securities, corporate bonds, etc.|
|Risks||An equity fund is relatively riskier than a debt fund. They are more suited for investors with an aggressive risk profile.||A debt fund is relatively less risky than an equity fund. They are more suited for investors with a moderate to low risk profile.|
|Returns||An equity fund has the potential to give inflation-beating high returns.||A debt fund has the potential to give low to moderate returns. The returns may or may not be able to beat inflation.|
|Investment time horizon||Investment in an equity fund is suited for investors investing towards long-term financial goals such as building a fund for a child’s higher education or own retirement where the investment time horizon is more than 7 years.||Investment in a debt fund is suited for investors investing towards short-term financial goals such as accumulating money for buying a vehicle where the investment time horizon is up to 3 years.|
|Taxation||Short-term capital gains (STCG) tax: If you sell your equity mutual fund units within twelve months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) tax will be levied at 15%.|
Long-term capital gains (LTCG) tax: If you sell your equity mutual fund units after twelve months of purchase, the capital gain will be classified as long-term capital gain (LTCG). Every financial year, the first Rs. 1 lakh long-term capital gain will be exempt from taxation. The incremental long-term capital gain above Rs. 1 lakh will be taxed at 10%.
|Short-term capital gains (STCG) tax: If you sell your debt mutual fund units within thirty-six months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) will be added to your overall income and taxed as per the income tax slab that you fall in.|
Long-term capital gains (LTCG) tax: If you sell your debt mutual fund units after thirty-six months of purchase, the capital gain will be classified as long-term capital gain (LTCG). The long-term capital gain (LTCG) tax will be levied at 20% with indexation benefit and 10% without indexation.
For building an investment portfolio for the long-term, asset allocation requires an investor to invest in various asset classes such as equity funds, debt funds, gold, real estate, etc. So, an investor can choose to invest in equity funds and debt funds separately. If investors wants exposure to equity and debt through a single mutual fund, they can invest in a hybrid fund.
To start investing in equity, debt, or hybrid mutual fund schemes as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started.