Know how equity and debt-based mutual funds differ in risk

Investment involves the act of allocating funds into investment tools. They are done with the aim to accumulate wealth over time. You can opt to invest either through lumpsum investment i.e., one-time investment or through a SIP. With the help of SIP i.e., a systematic investment plan money is deducted from your account regularly. One of the ways you can accumulate wealth over time is by allocating your funds into mutual funds.

Mutual funds are an investment product that pools money from a group of investors to purchase different securities like stocks, bonds, gold and money market instruments through an investment vehicle. After buying a unit in a mutual fund, you own a stake in all the investments falling under the fund. They are a good investment choice mutual funds are easy to manage, and they offer several advantages.

However, one thing to remember about mutual funds is that they are not a monolith. Some of the common types include equity funds and debt funds.

Equity funds:

Equity funds are known for investing a major part of their asset in equity shares of various companies in different proportions. Assets allocated in these funds are dependent on the type of the equity fund and its alignment with the investment objective. Depending on the market conditions, assets can be allocated in stocks of small-cap, mid-cap, or large-cap companies. After allocating funds to the equity segment, the remaining amount is invested in things like money market instruments and debt. This helps with things like bringing down the element of risk and taking care of sudden redemption requests. If you are considering investing in equity funds, you should make sure that your decision to invest must sync with things like your risk profile, investment horizon and financial objectives. In case you have a long-term goal, you should consider investing in equity funds. Doing so will provide your funds with the much-needed time to combat market movements and fluctuations.

Debt funds:

These funds invest primarily in debt and money market instruments like commercial papers (CPs), Treasury bills (T-Bills) and certificates of deposits (CDs). Debt market instruments include non-convertible debentures (NCDs), Government Bonds or G-Secs. The primary objective of investing in things like debt or money market instruments is enjoying income in form of interest payments. Apart from earning income, which is the primary investment objective in debt funds, some take interest rate calls can also generate capital appreciation for investors. The main difference between a debt fund and an equity fund is that debt funds have considerably lesser risks compared to equity funds.

Another major difference between the two is that there are many types of debt funds which help you invest even for one day to many years. For instance, overnight funds invest in instruments which mature overnight. Liquid funds allocate funds in securities which mature in less than 91 days.

How do equity and debt funds differ from each other?

Features Debt funds Equity funds
Instruments They invest primarily in things like commercial papers (CPs), certificates of deposits (CDs), Treasury bills (T-Bills), non – convertible debentures (NCDs), corporate bonds and Government securities (G-Secs). They invest in equities or equity-related instruments, such as derivatives
Return on investment Here, returns are between low and moderate in comparison to equity funds Comparatively higher returns compared to debt funds in the long term
Risk appetite Ideal for those who have a low or moderate risk appetite Suitable for those who have a high-risk appetite
Expense ratio The expense ratio of a debt fund is much lower compared to equity funds They are higher
Suitability These funds give you investment options from 1 day to many years with lower to moderate risk. It can be used as an alternate to fixed deposits and savings bank account They are for the long term and suitable for investors with moderately high to high-risk appetites. Equity funds may help reach your long-term financial goals
Tax Saving option Not many options to save on taxes It is possible to save on taxes by investing up to ₹150,000 a year in ELSS mutual funds

While equity funds are risky in the short term, in the long term they can provide superior returns. Conversely, debt funds can be helpful if you cannot tolerate high risk and are happy with low to moderate returns and the main aim is capital protection.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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