Financial Planning
Debt or Equity Funds: Which one matches your risk profile?
Understand the key differences between equity and debt mutual funds to invest wisely and build a balanced investment portfolio.
Key takeaways
- Equity funds have the potential to provide high returns but come with higher risk and volatility.
- Debt funds offer you stable returns with lower risk and are perfect for short-term goals.
- Your financial goals and risk appetite should guide your choice between equity and debt funds.
- A balanced portfolio of both helps you diversify risk and maximise long-term growth.
If you are new to the world of investing, you need to start with understanding mutual funds. India’s mutual fund industry is booming, allowing you to invest through Systematic Investment Plans (SIPs) or lump sum payments. As convenient wealth-building tools, mutual funds can be broadly classified into equity and debt funds. You can determine the allocation to debt and equity based on a careful assessment of your risk profile and financial goals. A general rule is to allocate more money towards equity assets for long-term financial goals and opt for debt assets for short-term financial goals.
Whether you prioritise wealth creation or are looking for financial security, the first step is knowing the difference between debt fund and equity fund.
Equity funds
When you invest in equity funds, you are actually buying shares and derivatives that are traded in the stock market. As a result, you become a partial owner of the company as per the number of units you own. One potential advantage of investing in stocks is the possibility of capital appreciation and receiving dividends.
You can broadly categorise equity funds into three categories:
- Large-cap funds invest in the top 100 large companies that offer stability and steady growth.
- Mid-cap funds include companies ranking between 101 and 250 that create a balance between growth potential and risk.
- Small-cap funds target companies ranked below 251 that offer high-growth opportunities but increased market volatility and risk.
Why choose equity funds?
Potential of high return
With equity investments, there is the potential for higher returns, as stock values rise with company growth and economic expansion.
High liquidity
Equity funds offer high liquidity as you can buy or sell your debt units when needed.
Offers diversification
By spreading your investments across various sectors and industries, equity funds help you diversify risk and limit the impact of underperforming stocks.
Budget-friendly
Equity funds are easier on your pocket than buying individual stocks because you can start with less money and still invest in a mix of companies.
Debt funds
If you are looking for low-risk investments, then debt funds could be the better choice. Debt funds prioritise investing in fixed-income securities like government bonds, corporate bonds and treasury bills that help you in avoiding the volatility of the market. These funds provide you flexible investment durations, which may range from as low as 1 day to several years. Just like fixed deposits or savings accounts, these funds offer predictable earnings and a steady income source.
Why choose debt funds?
Stable returns
Debt funds aim to provide a fixed return on investments with regular interest payments, making them a much safer bet than equities.
Multiple options
Debt funds are available for short-term and medium-term options. For instance, if you are investing for 3 to 12 months, you can opt for liquid fund. However, if you are looking at a 3 to 5-year horizon, consider dynamic bond funds or simply go for a conservative hybrid fund.
High liquidity
Just like equities, you can buy or sell debt fund units easily, offering you flexibility when needed.
Factors affecting equity vs debt funds
Use these tips to decide whether to prioritise and focus on equity or debt mutual funds.
Financial goals
When planning your investments, your equity and debt allocation should conform with your short-term and long-term financial goals. For short-term goals within a year or the near future, consider debt funds, as they offer stability, low to moderate risk, and quick redemption options. If you have an investment horizon of 5 to 7 years, equity funds are a preferred choice for long-term growth and wealth creation over an extended period.
Risk appetite
Align your investment strategy with your risk appetite, reflecting your tolerance for market fluctuation. If you prefer stability, debt funds are a safer choice. Understanding debt and equity mutual funds difference can help you achieve steady growth with controlled risk. If you're comfortable with higher risk, equity funds could potentially offer long-term growth, despite market volatility.
Note that investments in both debt and equity funds are subject to market risks. With equity funds, you face market risk, where stock prices fluctuate due to economic trends, global events, or policy changes. Industry-specific risks can also affect stock values, while currency risk impacts funds with global exposure. Debt funds may seem safer, but they come with their own risks. Interest rate fluctuations can lower bond prices, especially for long-term bonds. Credit risk arises if issuers fail to repay, and liquidity risk can force the sale of low-demand assets at a loss.
Professional portfolio management
If you're unsure how to determine your focus on debt funds and equity funds, a financial advisor can help you create a balanced portfolio. They assess your financial health, design a diversified portfolio, and adjust your investments in line with market trends and personal circumstances. With their expertise, they can help you aim to keep your portfolio optimised for potential long-term stability and growth, with the goal of making your investments work for you.
Conclusion
Mutual funds offer investor-friendly options. While equity funds have the potential for higher growth, debt funds can provide stability and a buffer against constant fluctuations in the stock market. Therefore, it may be beneficial to consider a balanced portfolio of debt funds and equity funds to diversify your investments according to your risk appetite.
Disclaimer:This article is intended solely for informational purposes. The views expressed in this article are personal. Axis Bank and/or the author shall not be liable for any direct or indirect loss or liability incurred by the reader arising from reliance on the content herein. Readers are advised to consult a qualified financial advisor before making any financial decisions. Axis Bank does not endorse or guarantee the accuracy of any third-party content or links included in this article.
Mutual Fund investments are subject to market risk. Please read all scheme-related documents carefully. Axis Bank Ltd. is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Any purchase of Mutual Funds by Axis Bank’s customer(s) is purely voluntary and not linked to availment of any other facility from the Bank. This content is for informational purposes only and does not constitute investment advice. Past performance is not indicative of future returns. Readers are advised to consult a qualified financial advisor before making any investment decisions. Terms and Conditions apply.
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