Mutual funds can be categorised broadly into debt funds and equity funds, and this is where many investors face the challenge of picking the right category for themselves. However, with a little bit of evaluation of certain aspects like investment objectives, investment tenure, and risk-taking capabilities, one can easily decide which fund will be suitable for his or her investment portfolio.
Equity Funds
An equity fund is a mutual fund scheme that invests predominantly in equity stocks. As per the market regulator, the Securities and Exchange Board of India (SEBI), an equity fund must invest at least 65% of the scheme’s assets in equities and equity-related instruments.
The company can be of any size, and according to the size of the company, equity funds are further categorised into large-cap, mid-cap and small-cap funds. There can be other categories as well, which are based on specific themes of investments, objectives, or industry-specific funds. Still, the primary thing is that these funds invest most of their corpus into equities and equity-related instruments of listed companies.
Equity funds have their own set of pros and cons. For instance, equity funds can offer higher returns of around 12% over the long term. The returns from small-cap funds which invest in growing companies have the potential for higher returns when the market is going well. However, it is important to note that these funds also come with higher risks.
Equity funds can be rewarding in the long run, while in the short term, they can also turn out to be a nightmare for investors. This is due to the volatile nature of the stock market. Equity funds get affected directly when the prices of the underlying stocks go down. Thus, if someone is looking to invest for less than three years, equity funds may not be a suitable option for them.
So, if you are looking for higher returns on your investment, you need to choose equity funds but stay invested for a longer span.
On equity funds, short-term capital gain taxes are levied when an investor sells an equity fund within 365 days or a year from the day of investing in the fund. At present, 15% of taxes are levied as short-term capital gain tax. Now, if a person holds on to the fund for more than a year or 365 days, to be specific, then when they redeem the fund, long-term capital gain taxes at the rate of 10% will be levied on profit over and above Rs. 1 lakh.
Debt Funds
Now coming to debt funds, these are mutual funds which invest in assets like bonds, treasury bills, money market instruments, and other fixed-income instruments. Debt funds are usually categorised based on the maturity of the underlying assets. There are overnight funds, ultra-short-term funds, liquid funds, and others.
Debt funds are known for their low-risk factor as they invest in less volatile instruments than the equity market.
These funds are also for those looking to invest their funds for the short term, where the capital isn’t affected much, and the returns are almost stable. Due to its low volatility, these funds can be good for people close to their retirement as well. At this stage, the investor aims to safeguard their life savings while also seeking a reasonable return on their investment.
Coming to the taxation of gains from debt funds, irrespective of the holding period, the capital gains from the debt funds are added to your income and are taxed as per your current income tax slab. So, if you fall under the 30% tax slab, the profits you make from debt funds will be taxed at 30%.
Final thought
All that said, the investor’s ultimate decision needs to be based on a wise evaluation of his objective for the investment, the amount of risk they are willing to take and able to take, the tenure of investment, and after-tax returns. Since every investor is different, their funds’ choices must be different as per their needs and preferences.
However, equity funds and debt funds don’t have to be mutually exclusive, and you can invest in both these categories of funds to fulfil your various financial goals.
