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Mutual funds provide a diverse range of investment options to cater to a variety of financial needs, tenures, and risk appetites. Depending on their stage of life and financial condition, individual investors have wide-ranging financial goals and risk appetites. Furthermore, a single investor can also have more than one financial objective at a given point in time.

There is a common misconception that all mutual funds are the same. There are several sorts of funds, the most common of which are equity and debt funds. Where the money is invested is the distinction between the two. 

Equity funds engage primarily in equity shares and related securities, whereas debt funds invest in fixed income instruments. The features of both equities and fixed income instruments influence how the respective schemes will perform.

Equity Funds

An equity fund principally invests in stock, which is why they are often referred to as stock funds. It can be managed actively as well as passively. There are primarily categorized based on the company size, the portfolio’s holdings’ investment approach, and geographic location.

The market capitalization of an equity mutual fund determines its size, and the investment strategy represented in the fund’s stock holdings is also used to categorise equity mutual funds. Domestic and international equity funds are likewise divided into two categories. These funds can be global, regional, or country-specific.

Some specialised equity funds focus on certain industries including health care, merchandise, and real estate.

In many ways, equity funds are perfect investment vehicles for investors who aren’t as knowledgeable about financial investing or who don’t have a lot of money to invest. For most people, equity funds are a viable investing option.

The reduced risk arising from a fund’s portfolio diversification, as well as the comparatively modest amount of capital necessary to acquire shares of an equity fund, make equity funds ideal for small individual investors. To attain a similar level of risk reduction through diversification of a portfolio of direct stock ownership, an individual investor would need a significant amount of investing cash. An equity fund can successfully diversify without burdening each investor with large capital requirements by pooling small investors’ resources.

Debt Funds

A debt fund is an investment pool, such as a mutual fund or an exchange-traded fund, with fixed income investments as its principal holdings. A debt fund can invest in short- and long-term bonds, securitized securities, money market instruments, and floating-rate debt. Since the overall management costs are lower, fee ratios on debt funds are on average lower than those on equity funds.

Debt funds, often known as credit funds or fixed income funds, are a type of fixed income asset. Investors seeking to conserve capital and/or achieve low-risk income distributions frequently seek out these low-risk instruments.

Debt funds can invest in a wide range of securities, each with its own set of risks. Companies with a steady outlook and excellent credit quality issue investment-grade debt. High-yield debt, which is primarily issued by lower-credit-quality enterprises with emerging growth possibilities, delivers larger yields but also carries a higher risk profile. Developed market debt and emerging market debt are two more types of debt.

Difference between the two funds

• Instruments: Debt funds invest largely in money market instruments such as commercial papers, or government securities. On the other hand, equity funds invest in equity-related instruments such as derivatives.

• ROI (Return on Investments): low to moderate with debt funds, and higher as compared to debt funds in the long term with equity funds.

• Risk Appetite: Debt funds have a low to moderate risk, whereas equity funds involve a moderately high to high risk.

• Expenses: The expense ratio for debt funds are comparatively much lower than equity fund expense ratio.

• Timings: The time to sell or purchase debt funds is not crucial, but the duration is very important. Because the stock market is quite active and may be very turbulent at times, buying and selling equities at the right time is crucial.

• Suitability: debt funds offer 1 day to many years of investment at a low to moderate risk, but equity funds are a long term investment suitable for investors with moderate to high risk appetite.

• Taxation: Debt funds held for less than 36 months are taxed at the investor’s marginal tax rate and after that the capital gains are taxed at 20% after taking into account indexation benefits, capital gains from equity funds held for less than 12 months are taxed at 15% and beyond that duration capital gains of up to Rs 1 lakh is tax exempt and taxed at 10%.
  
  
• Tax saving: Debt funds have no option to save taxes, and equity funds can save taxes with an investment up to Rs 150,000, a year, in ELSS funds.

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