Equity fund or hybrid fund: Which is a better investment option for you?

Application, not access, is important from the perspective of knowledge, tools, and investments. Hence, simply investing in mutual funds is not beneficial. Instead, knowing which mutual fund to invest in for a given purpose and in what way is more beneficial. Read on to know whether you should invest in equity mutual funds or hybrid mutual funds.

Equity fund vs hybrid fund: Which to select?

This decision can be made only after you understand how your risk tolerance, financial goals, and investment horizon align with the risk-return profile and other features of equity and hybrid funds. Here’s what you need to consider:

1. Underlying securities

Equity mutual funds invest primarily in stocks and other equity-linked instruments such as derivatives. By contrast, hybrid funds invest in both equity instruments, such as stocks, and debt instruments, such as government securities, bonds, and money-market instruments.

Hence, equity funds invest primarily in only one asset class, namely equity, whereas hybrid funds invest in both equity and debt. For this reason, hybrid funds offer a higher level of diversification than pure equity funds.

2. Types of funds

There are several types of equity and hybrid funds. Equity funds are categorized based on the market capitalization of the companies in which they invest in as large-cap, mid-cap, small-cap, and multi-cap funds. Moreover, they are categorized based on their investment objectives and other features as value, dividend yield, contra, and thematic funds.

Hybrid funds are categorized primarily based on whether they are more equity focused or debt focused. The types of hybrid funds include conservative, balanced, aggressive hybrid funds, as well as balanced advantage, multi-asset allocation, arbitrage, and equity savings funds. Each of these types have specific mandates pertaining to the asset allocation between debt and equity to help investors with different risk tolerances achieve different investment objectives.

3. Risk level

Equity mutual funds carry a higher level of risk because they are market-linked investments, and the stock market is inherently volatile. Stock prices fluctuate on a daily basis and are influenced by diverse macro and microeconomic factors. Such volatility is a double-edged sword, and it has potential to lead to capital loss or gain.

Conversely, because hybrid funds invest in both equity and debt instruments, the overall risk level of a hybrid fund’s portfolio may be lower than that of a pure equity fund. The debt component of a hybrid fund’s portfolio hedges the risk of the equity component.

4. Investment objective and horizon

The primary objective of equity funds is capital appreciation, and to this end, the ideal investment horizon is long term. There are two reasons for this. First, because the stock market is volatile in the short term, a long-term investment horizon is needed when investing in equity funds so that your investment has the time to iron out short-term market fluctuations. Second, the longer you remain invested in equity funds, the more powerful may be the effect of compounding on your returns and overall investment.

The investment objectives of hybrid funds are capital appreciation but with lower levels of risk. The equity and debt components of the portfolio aim to realize capital appreciation and protection from volatility, respectively. For hybrid funds, the ideal investment horizon is medium to long term.

When to pick equity funds?

When your investment horizon is long term, that is, more than five to seven years; your risk tolerance is high; and your financial goals require significant capital appreciation, you would do well to consider investing in equity funds.

For instance, your goal is to save for the down payment on a house, and you have eight years to fulfill this goal. Meanwhile, you have a stable job with an income that is poised to increase over time, and you have little to no debt to service. In this case, your overall risk tolerance may be considered high, and you may consider equity funds.

When to pick hybrid funds?

When your investment horizon is comparatively more medium term, your risk tolerance is lower, and your financial goals require a balance between capital appreciation and capital preservation, you may consider hybrid funds.

Let us say you wish to fund your wedding, which is about three to four years away, and you already have a significant amount of money saved up. However, you wish to park that money in a safe investment and accrue good returns. In such a case, you may choose to invest in a hybrid fund.

Final words

It is important to understand that equity funds and hybrid funds are not mutually exclusive investments. This means that you need not pick one over the other. You could invest in both types of mutual funds to help fulfill different financial goals over different investment horizons because each type of fund offers a unique set of benefits and risks. Use a mutual fund app to easily track and manage your investments across these diverse funds.

Source: Axismf Research
Note: Market caps are defined as per SEBI regulations as below: a. Large Cap: 1st -100th company in terms of full market capitalization. b. Mid Cap: 101st -250th company in terms of full market capitalization. c. Small Cap: 251st company onwards in terms of full market capitalization.

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