With a large number of options available, choosing the appropriate mutual funds (MFs) to invest your hard-earned money may be difficult. Prior to deciding on which funds to invest in, you need to choose between debt and equity schemes.
There is no standard rule that applies and it varies on your personal requirements. Let us understand the difference between debt and equity schemes.
Investment risk
Debt funds are less risky because the MF corpus is invested in fixed-income securities. These include company debentures and fixed deposits, government bonds, and commercial papers. However, these do not provide guaranteed returns. Debt funds offer returns that depend on the inflation, which makes these superior to fixed deposits (FDs).
Equity funds are an important instrument to achieve long-term returns that often exceed the inflation rate. Such types of schemes invest in company shares and deliver higher returns over a longer duration. If you are investing for a long period, opting for equity funds is recommended.
Here are five factors that may be beneficial in helping you make an informed decision.
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Financial goals
Your objective may either be to build wealth or generate income. Debt funds are recommended if your financial goal is income generation. However, to build wealth over the longer term, investing in equity funds is advisable.
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Investment tenure
You must invest in either debt or equity mutual funds based on the investment tenure. If you require the capital in a shorter period, opting for debt funds is advisable. However, if your investment horizon exceeds five years, choosing equity schemes is beneficial.
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Expected returns
It is important that you have realistic expectations from investment returns. The return on investments from every asset class varies based on its riskiness and uncertainty. The average returns on debt funds are estimated at 9% while equity schemes may deliver returns around 16.
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Tax implications
When you remain invested in equity funds for one year or more, there are zero tax implications. On the other hand, debt funds entail short-term capital gain taxes if you exit your investment before three years from the date of investing. Furthermore, even if you exit from the debt fund after three years, the same is liable to long-term capital gain taxes.
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Risk appetite
Your risk appetite must complement your financial goals and expected returns. The variation in returns for debt schemes is lower, which enables these to deliver around 9% returns in the long-term. The effective returns would be between 8% and 10%. In other words, you may assume a higher possibility of being able to earn at least the average rate of returns. In comparison, returns on equity funds vary a lot along with the risk of losing the entire capital investment. However, you may reduce the risks by staying invested for a longer period.
It is difficult to choose the right MF investment schemes. You may make your decision based on the aforementioned factors. You may also opt for systematic investment plans (SIPs) to invest your money at periodic intervals.
Moreover, it is important you take the efforts to conduct extensive research and compare different MF schemes.