Equity vs Debt vs Liquid Mutual Funds: Which kind of MF is most suitable for you?

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Updated: Mar 19, 2018 1:00 PM

Investing in mutual funds can be a tricky affair. However, with more scope for investors now and a variety of funds to invest in, one can start considering investments in this medium.

Equity vs Debt vs Liquid Funds: Which kind of mutual fund is most suitable for you?Mutual funds are of various types and it may confuse a new entrant with regards to the field they are entering.

Investing in mutual funds can be a tricky affair, especially for those who have always favoured the traditional saving methods of fixed deposits or pension plans. However, with more scope for investors now and a variety of funds to invest in, one can start considering investments in this medium.

Mutual funds, however, are of various types and it may confuse a new entrant with regards to the field they are entering. Equity, debt, gold – these all are terms you may have heard of when reading on funds but not quite sure where to start with or which one most suits your needs. We will tell you some basics of these funds, how they work and what are their tax implications.

Broad Types of Mutual Funds

By investment object there are broadly four categories of funds — Equity, Debt, Money and Gold. Under this, equity has further categories like large-cap, small cap, mid cap and even sectoral and thematic funds. While some funds may be a combination of more than one type of fund, if a fund invests more than 65% of its portfolio in stocks, it is generally considered as equity fund. ELSS also comes under these category of funds. Since investing in this category is closely related with market movements, it requires you to do a thorough research before you can start investing.

Debt funds, on the other hand, pool money raised from people and invest it in fixed income instruments like government bonds, corporate bonds, non-convertible debentures and other highly-rated instruments. So, short-term investors generally do not find any gain in opting for these funds as they require a longer commitment period. There are short-term bonds too, but their volume in the market is not as much as the long-term ones.

Liquid funds meanwhile are open ended schemes that invest in debt and money market instruments with maximum maturity of up to 91 days only. This strategy helps in mitigating risk arising out of interest rate volatility, providing high liquidity to portfolio and generating stable income. The returns may be tapered, and not as great as equity funds but they are safe options, especially for those looking for an alternative to their fixed deposits.

How Risky They Are

Equity funds can be said to be the riskiest of the lot as they are directly affected by market movements. As they invest in stocks, any change in share prices will have a corresponding impact on the Net Asset Value (NAV) of the fund. Despite the risk factor, one should remember that a good equity mutual fund scheme will invest their corpus in multiple companies or industries providing diversification, which makes it less volatile as compared to equity markets.

Debt funds are long-term and thus less liquid as they primarily invest in rated bonds and in which defaults are rare. Government bonds are generally considered risk-free, but may take a long time to convert. Corporate bonds on the other hand are rated by different credit rating agencies which allow the investor to gauge the risk of the investment. Even in the case of debt funds, bond prices are sensitive to interest rate changes. They may be safer than equity funds, but are not totally risk-free.

If we are to make a general assessment, in volatile times debt funds are generally considered as a good investment. But when times are good with markets booming, equity funds are a feasible source to seek returns.

Liquid funds are the least risky of them all. It is ideal for those who wish to park some large funds. Do not expect much return from them, but they are a safe bet when it comes to parking funds. Gold ETFs more or less carry the same risk as investing in gold and are for investors who want to take exposure to gold via mutual funds.

Taxation

All funds will attract tax to some level, and on redemption too barring gold bonds which don’t attract tax on redemption. The short-term taxes are higher of course as shown in the table below, while long-term taxation is lesser. In terms of taxation, equity and corporate bonds have low tax for long-term investors. One can also claim capital loss if they end up losing money on select funds from their portfolio.

Short and long term capital gain tax on various investments

Instrument

Short Term

Long Term

Duration

Tax

Duration

Tax

Gold< 3 YearAt applicable Slab Rate> 3 Year20% (with indexation benefit)
Sovereign Gold Bond< 3 YearAt applicable Slab Rate> 3 Year20% (with indexation benefit)
* On redemption: No Tax
Equity Mutual Fund< 1 Year

15%

> 1 Year

10% above gains of Rs 1 lakh (no indexation benefit)

Debt Mutual Fund< 3 YearAt applicable Slab Rate> 3 Year20% (with indexation benefit)
Liquid Funds< 3 YearAt applicable Slab Rate> 3 Year20% (with indexation benefit)
Corporate listed Bond< 1 YearAt applicable Slab Rate> 1 year10% (No Indexation Benefit)
*Tax rate excludes cess and surcharge, if any
Data as on 5 March 2018

Before polling any money in these funds make sure to consult your financial advisor to know which funds suit your needs the most.

(The writer is CEO at Bankbazaar.com)

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