Equity or debt funds? Which is more suited for you?

A mutual fund is a professionally managed investment that pools the funds of many investors and invests them in assets like stocks, bonds, money market instruments, commodities, etc. Given the range of categories and sub-categories of mutual fund schemes available to investors, it is natural to get confused. A large part of this discourse is divided over the choice between equity funds and debt funds.

As an investor, what should you choose?

The Case for Equity Funds

Equities offer the scope of wealth creation over the long term. You can also benefit from the power of compounding and make the most of market cycles with systematic investment plan (SIP) via mutual funds.

When mutual funds invest at least 65% of their corpus in stocks and stock-related instruments, they are considered as equity mutual fund schemes. Each investor stands to benefit from the stocks the mutual fund invests in without owning them directly.

Professionally skilled and experienced fund managers invest funds in equities based on certain objectives and strategies. Based on the underlying parameters and mandate of the equity scheme, the fund managers invest in a portfolio of stocks, with the aim to optimize the balance between risk and returns.

If you are someone who is a novice or even someone who does not have the time to do your own research, an equity mutual fund can act as a viable option for investing.

Investing in equities typically comes with high risk due to the volatile nature of stock markets.

The case for Debt mutual funds

Debt or fixed income securities involve less risk as compared to equities as they are less volatile. This is because they come with fixed interest for a pre-defined duration. These securities may appreciate or depreciate due to bond price movements. However, not all debt securities are easily accessible to retail investors. Moreover, investors need to keep a hawk’s eye over monetary policy updates and macroeconomic indicators as well as review the credibility of the issuers of debt to ensure that there is no misstep that will lead to losses.

This is where debt mutual funds can help. Debt funds can give you access to gamut debt securities that are not easily available to retail investors. You get to invest across the curve and test various maturities and yields to identify the optimal mix. Liquidity, capital preservation, stability, and proactively mitigating risk are the qualities that make debt funds stand apart.

All this is actively undertaken and overseen by qualified and knowledgeable fund managers who understand the beat of debt markets and strategize basis the economic climate.

However, the scope of returns is usually tantamount to the risk you are willing to take. So, while debt funds may give you room for steady income, they are not the best when it comes to generating alpha.

So, what should you choose?

Just a cursory reading of the above sections would suggest that investors who can bear risk should choose equity funds while those that prefer less volatility should choose debt funds. But, that’s not necessarily true.

While equities and debt are widely seen as alternatives, this belief is faulty. A portfolio holding only equities is susceptible to the whims of the market, and having only debt can make you miss opportunities for wealth creation.

Just as in life, you need balance in your portfolio too! Only when you have a well-diversified portfolio, can you shelter some portion of your capital from extreme events and also make the most of market rallies.

Thus, if you shift your perspective, and see equity funds and debt funds as complements rather than alternatives, you’ll open yourself to a wide array of investing possibilities. Because they have low correlation to each other, they work like yin and yang to restore portfolio balance.

Now, the question arises - what is the right proportion of equity and debt exposure for me? This differs from person to person.

Generally speaking, the split between equity funds and debt funds can be determined by your age, financial goals, and risk appetite. A conservative investor may prefer their portfolio to be skewed towards debt funds, while an investor with a high-risk appetite may prefer to own a larger proportion of equity funds.

Investors also have the option to invest in balanced funds, which give access to both equities and debt in varying proportions.

Statutory Details: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882.sponsored by Axis Bank Ltd.(liability restricted to 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd.(the AMC).

Mutual fund investments are subject to market risks, read all scheme related documents carefully.