Ever thought of making your money work for you? Well! Guess what — the financial world offers you one such avenue, called mutual funds. And if Equity vs Debt Funds is a question, let’s help you find out more.
Mutual funds only require you to invest money. The task of generating returns is left to the professional expertise of fund managers (finance gurus who invest your money in a bunch of instruments, like equities, bonds, etc.) and the markets. You don’t have to continue tracking your investments, or even read sleep-inducing stock market reports. Mutual fund houses charge a negligible fee (expense ratio) to select company stocks to be invested in. The name of the mutual fund scheme generally points to how the fund will be managed or what it invests in. There are two branches that funds broadly fall in, Debt and Equity. If you are wondering what these are and how to invest, that’s exactly what we are getting at. Here is a quick guide to Equity vs Debt Funds.
Risk and investment type
The key difference between the two is based on the type of securities the shareholder’s money is invested in. The investment portfolio of equity funds majorly comprises equity and equity-related instruments (such as stocks). Debt funds on the other hand invest primarily in fixed-income securities (such as bonds).
Equity funds are more susceptible to market changes and thus the returns delivered by them are market-dependent. For instance, when the economy is booming, the returns are exponential (even around the lines of 20-25% annually), but when there are market crashes and economic meltdowns, there is a possibility of losses. This uncertainty makes equity funds a risky investment option. However in the long run, the risk is compensated by the potential of high returns.
Debt funds are considered to be relatively less risky compared with equity funds. They primarily invest in fixed-income securities, where the return is often guaranteed. Since there is lower risk in debt funds, the return on investment is also less as opposed to that from equity funds. However, these funds are perfect for investors with low risk appetite.
What should your investment look like
Both equity and debt funds have an ideal and varied investment horizons. Investment horizon is the number of years you wish to remain invested. This plays an important role in finding which fund is suitable to you. A long term investment horizon, preferably above 5 years is the industry recommendation for equity funds. If you stay put for a longer period, say 10-15 years, there is a higher probability of earning inflation-beating high returns. On the other hand, a short-term investment horizon, ranging from 1-3 years is good for debt funds. Funds with shorter maturity periods (6 months or 1 year), can serve as a source of additional regular income, or short term gains.
One important thing to keep in mind about you investment portfolio, is asset diversification, which is just a fancy way of saying, “don’t put all your eggs in one basket”. Even if you have a long term investment horizon, it is advisable to avoid a pure equity portfolio. A dash of debt can help you sail the boat even during rough storms such as economic downturns. When there’s a slowdown and the stock market tanks, reducing interest rates is the go-to solution for central banks, this consequently increases the returns from debt funds. Thus, losses from equity funds can be balanced by gains from debt funds.
A quick self-assessment of your risk appetite, financial goals and investment horizon, should help you choose your portfolio. You will have a higher chance of earning significant returns, if you understand the key takeaways in each type of investment. It shouldn’t really be a Equity vs Debt funds model but a mix and match one. This will set you up for maximised returns with balanced risks, albeit if you are patient.