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Mutual funds are an excellent way to invest in the stock market. They provide decentralization. So, if you own a mutual fund and it's performing poorly, you won't lose as much money as if you owned individual stocks. Mutual funds also offer higher returns than individual stocks, so you can get more out of your investment. Mutual funds invest in various financial instruments such as stocks, government bonds, corporate bonds, bonds and gold, depending on the mandate of the scheme. Disciplined and systematic investment by mutual funds can work wonders if planned well. Broadly speaking, the two most common types of mutual funds are equity investment funds and debt investment funds.

What are Equity Funds?

Equity mutual funds aim to generate high returns by investing in stocks of companies of all market caps. Equity funds are the riskiest class of mutual funds and therefore have the potential to generate higher returns than bond and hybrid funds. A company's performance has a significant impact on its returns to investors. Asset allocations can only be made in large-cap, mid-cap, or small-cap stocks, depending on market conditions. The investment style can be value oriented or growth oriented. After a substantial portion has been allocated to the equities segment, the remaining amount may be allocated to fixed income and money market products. This is to accommodate sudden redemption demands and reduce the level of risk to some extent. Fund managers make buy and sell decisions to maximize returns by taking advantage of changing market movements.

Equity Funds are: –

  • Historically Best performing asset class in the long term: The Bombay Stock Exchange (BSE) Sensex has given 11.6% CAGR returns which is significantly higher than other asset classes like bank fixed deposits and gold.
  • Risk Diversification: A diversified portfolio of stocks across different sectors considerably reduces company or sector-specific risks.
  • Professional fund management: Stock selection requires expertise and experience in investment management. The track record of fund managers of an AMC is available in the public domain.
  • Start investing with small amounts: Invest through Systematic Investment Plan (SIP)mode with instalments of just ?100 or ?500 a month, depending on the fund house.
  • Tax Advantage: Significant tax advantage overmost other investments.
  • Long term (investments held for more than 12months) capital gains are tax-free up to ?1 Lakh in afinancial year and taxed at 10% thereafter.
  • Short term (investments held for less than 12months) capital gains are taxed at 15%.

What is a Debt Fund?

Buying a debt security can be viewed as lending money to the issuer of the debt security. Debt funds invest in fixed income securities such as corporate bonds, government bonds, treasury bills, commercial paper, and other financial market instruments. The main reason to invest in debt funds is to get stable interest income and capital appreciation. The bond issuer pre-sets the rate and term it will receive. Therefore, they are also called "fixed income" securities.

Debt funds that invest in higher rated securities are less volatile than lower rated securities. In addition, this period also depends on the fund manager's investment strategy and the prevailing interest rate system in the economy. Falling interest rates encourage fund managers to invest in long-term securities. Conversely, when interest rates rise, he will be tempted to invest in short-term securities.

In Debt funds: –

  • Variety of solutions for different investment needs: Invest in funds of low to moderately low to moderate risk profiles appetite and different investment tenures, e.g. few days, weeks, months or 1, 2, 3 years or even longer. Suitable for Systematic Transfer Plan (STP)in equity or hybrid funds.
  • Liquidity: Redeem open-ended debt funds any time. No charges if redeemed after the exit load period. Some debt fund categories may not have any exit load at all.
  • Tax efficiency: Tax is payable only on redemption.
  • Short Term Capital Gains (STCG)- if the investments were held for less than 3 years.
  • Long-Term Capital Gains (LTCG)- for tenures of 3years or more. LTCG is taxed at 20% after allowing for indexation, reducing your tax outgo.
  • Potential higher and stable returns than traditional products: Debt funds have outperformed bank FDs on an average, despite FD’s assured returns. Relatively lower capital risk as compared to other asset classes, e.g. equity.

In conclusion, Debt funds are on the higher side of average returns when compared to other types of funds and provide an assured return. They are quite low in risk and hence are safest for those investors who want regular income even if the capital takes a blow.

On the other hand, equity mutual funds have given higher returns over the years and have a greater potential of providing better returns than debt funds, but it depends on whether you invest in front-loaded debt funds or otherwise.

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