It is a myth that mutual funds are risky investments. Mutual funds come in various forms and offer flexibility and portfolio diversification for adequate risk management and maximising returns. Among popular categories, debt mutual funds are commonly preferred by investors for safe returns and better security during adverse market situations.

This article examines the key differences between equity mutual funds and debt mutual funds and which one you should choose based on your financial planning.

Equity mutual funds v/s debt mutual funds

Equity and debt funds are two categories of mutual fund investment. They majorly differ in the choice and instrument of investment. An equity mutual fund invests in equity-oriented instruments such as stocks while a debt fund invests in corporate and government bonds securities.

For individuals with a higher risk appetite, equity funds make more sense than debt funds because they offer a longer investment horizon and better returns due to market volatility. On the other hand, a debt mutual fund return is comparatively lower than equity funds due to the lower risk involved and shorter investment tenure.

Understanding an equity mutual fund

Equity mutual funds are common among investors in India. A mutual fund is categorised as an equity fund if it invests more than 60% of the total assets in equities, such as company stocks. These funds provide an opportunity to invest in listed and unlisted companies which offer shareholding that can be purchased and sold anytime.

The equity mutual fund returns depend on the stock market indices, which fluctuate based on factors like government policies and global demand. The main advantage of these funds is that they may offer better returns than debt funds since you can invest for growth. However, equity funds also have a higher risk involved in case the market performs adversely.

Understanding a debt mutual fund

Debt funds are a category of mutual funds that invest in instruments like government and corporate bonds, debentures, and treasury bills. These funds tend to offer fixed returns and have a shorter investment horizon. After deducting the fund management expenses, these funds generally offer lower returns than equity funds.

Debt funds usually have a higher expense ratio than equity funds because they offer a wider diversity and require proper risk management. These funds are suitable for investors with low-risk appetites and those looking for inflation-beating returns.

Which funds should you choose between debt funds and equity mutual funds?

A choice of a mutual fund depends on your financial planning and investment objectives. As an investor, it is crucial to make a balance between the sets of mutual fund investments to mitigate risks and maximise benefits.

An equity fund is viable for individuals searching for higher capital appreciation and capable of taking more significant risks. In contrast, debt funds are suitable for investors with low-risk tolerance and anticipate medium and stable returns.

However, a mix of both debt and equity funds can serve you the dual purpose of effective risk management and better capital appreciation over the period.

Both debt and equity funds are sub-categories of mutual funds, but they vary in how they are invested in various instruments. While a debt fund focuses on investment in government and corporate bonds, treasury bills, and notes, equity funds invest in companies’ stocks for capital gains. As an investor, you must outline your investment objective and risk tolerance when investing in these mutual funds.