Debt Funds or Equity funds: What Should a Beginner Select?

There are currently more than 2000 different mutual fund schemes in India from more than 40 AMCs. Needless to say, select one for your investment can be challenging. But even before you start browsing through the schemes, you first need to choose between debt and equity funds.

With so many new investors now planning to invest in mutual funds, it is very important first to be able to select between the two before one starts browsing through the top schemes. Continue reading to know how a beginner can choose between the two.

1. Investment Goal

Every investor has a different financial goal which they’d like to achieve with their mutual fund investment. It could be earning better returns than FD on surplus funds, long-term wealth generation, or income generation.

Equity schemes are generally recommended if you have long-term goals like retirement planning, child’s education, and wealth generation. On the other hand, if you are looking for fixed income or short-term goals, debt schemes can be great.

2. Risk Appetite

Selection between equity and debt also relies abundantly on your risk appetite. As equity funds depend on the equity market, they are riskier than debt schemes which invest your money in fixed income instruments like company debentures, bonds, etc.

So, if you are new to mutual funds and consider yourself as a risk-averse investor, prefer debt schemes or at least large-cap equity schemes. If you don’t mind the risk, especially if you are looking for long-term investment, equity schemes are highly recommended.

3. Your Age

Even your age is an important consideration when selecting the right mutual fund. When you are young, especially in your 20-30s, you have a longer period to let your investment work as compared to someone who is in their 40s or 50s.

While your investment objective and risk appetite would play essential roles in the selection, equity funds are generally recommended for younger investors with a long-term investment horizon. As you age, your risk appetite falls, and you look for safer investments, making debt schemes the right choice for you.

4. Returns Expected

Every investor planning to invest his/her money in mutual funds is doing so with an expectation to earn higher returns as compared to traditional instruments like FDs. However, the returns can vary significantly between equity and debt schemes.

While equity schemes are very popular for their huge returns potential, debt schemes are more popular for their safety. Returns in the range of 12%-15% are very common with equity while debt schemes returns are generally in the range of 8%-9%.

5. Tax Liabilities

While equity schemes were more tax efficient in the past, the long-term capital gains tax on gains of more than Rs. 1 lakh has been increased to 10% in the last union budget of 2018. However, there are still ELSS funds which offer excellent tax savings.

With debt funds, short-term capital gains (holding period of less than 36 months) are added to your annual income and taxed as per your income tax slab. Long-term gains (holding period of more than 36 months) on the other hand are taxed at 20% with indexation benefit.

As you can see, equity and debt schemes both have their unique benefits. To select between the two, an investor needs to consider his/her objective, risk appetite, age, return expectation and tax liabilities. Once you’ve thoroughly analysed these factors, you sure would be able to make the right decision.