Many people have a common misconception that all the mutual funds available in the market are the same. However, this is not the case, there are different types of mutual funds. The most popular of all these types are equity funds and debt funds. The difference between these two depends on where the money is invested. Debt funds invest in fixed income securities, whereas equity funds invest in equity shares and related securities. Equity and fixed income securities offer different properties and those are the deciding factors that impact returns on investment.
Let’s understand these two types of funds and the difference between them
Meaning
Debt fund – Debt fund is a type of mutual fund that enables you to invest your money in fixed income securities such as bonds and treasury bills. A debt fund can be an investment made for short term as well as long term bonds, money market instruments, scrutinized products or floating rate debt.
Equity funds – Equity funds, also known as stock funds, are mutual funds that invest shareholder’s money principally in stocks. These funds are primarily categorized depending on the company size, the investment style of the holdings in portfolio and geography.
Nature of funds
Debt Funds – The money collected from the shareholders gets invested in fixed income instruments such as corporate bonds, high-rated instruments, and non-convertible debentures.
Equity Funds – In case of equity funds, the money raised from investors is invested in equity and equity-linked instruments. For example, a portfolio with more than 65% invested in such funds is usually considered as equity funds.
Risk Factor
Debt funds – Debt funds are safer in terms of risk factors in comparison with equity funds. It is because they primarily invest in funds such as government and corporate bonds. There is merely any risk involved in government bonds, although in corporate bonds, you must check ratings before investing money. It is because the bond prices are sensitive to changing interest rates. There can be a corresponding fluctuating Net Asset Value (NAV) of the fund.
Equity Funds – Equity funds areriskier than debt funds due to their volatile nature and sensitivity towards economic factors like tax rates, inflation, bank policies, etc. Therefore, any change in market prices has a direct impact on the NAV of the fund.
Tax Liabilities
Debt Funds – Debt funds held for more than 36 months are taxed at 20% with indexation. For short term debt funds, the capital gain is added to the total income of the investor, which gets taxed as per the income tax slab in which the investor falls.
Equity Funds – The long term equity terms are exempted from capital gain taxes. Although, equity funds held for 12 months or less are taxed at 15% flat.
Returns
Debt Funds – Debt funds offer steady returns but only in a constant range. It is a great option when the market is volatile.
Equity Funds – Equity funds offer good returns if invested for a longer term. But at the same time, it carries the risk of higher losses.