Equity Vs Debt Mutual Funds – Returns, Tax And How To Choose

All investors face one key decision at the start of their mutual fund journey–should you invest in equity mutual funds or debt mutual funds? Both aim to grow your money but cater to very different needs. While equity funds focus on growth through stocks, debt funds prioritise stability and regular income through bonds and fixed income instruments.

Your choice depends on factors like risk appetite, time horizon and financial goals. Equity funds are better suited for long term wealth creation, while debt funds work well for short term planning and capital protection. 

In this blog, we explore the differences between equity and debt mutual funds to help you make the right investment choice.

Comparison: Equity Vs Debt Funds 

Debt vs equity mutual funds vary in terms of return potential, risk involved, and volatility. These are given below:

1. Historical Average Returns: Equity Vs Debt 

Equity vs debt returns comparison can help you determine which type of fund is more suitable for your expectations.

Let us consider some of the popular equity and debt mutual funds and their historical returns:

A. Equity Mutual Funds

B. Debt Mutual Funds

Equity funds provide higher returns, particularly if you keep them for 5 years or more. Debt funds provide stable, but lower returns. These figures are from top top-performing large-cap and diversified mutual funds in the last 10 years. 

Example: INR 1 lakh in an equity fund like SBI Contra Fund and in a debt fund like ICICI Prudential Long Term Bond Fund - Direct Plan – Growth, the growth may be:

As you can see, equity funds have the potential to offer higher returns compared to the debt fund for a 5-year period. However, due to volatility in the market, the returns dipped in the first year, but picked up in the subsequent years. This highlights the risk involved in equity fund investments. 

2. Equity vs Debt: Risk And Reward

Equity markets go up and down. So do equity funds. They can surge high or plummet swiftly depending on market tendencies. That is why they are more volatile.
Debt funds are steadier. Their price varies slowly. They have less market risk but are not risk-free. There are some debt funds that can invest in low-grade bonds or respond to higher interest rates.
For a fair comparison, we can use the Sharpe Ratio. It informs you about how much return you receive per unit of risk. On a long-term basis, equity funds tend to have higher Sharpe ratios than debt funds.

3. Real Returns After Accounting For Inflation 

When inflation is 5% (for example), the actual purchasing power of your returns decreases. This is referred to as your “real return.”

• Equity funds tend to provide 7–12% real return after inflation adjustment.
• Debt funds can only provide 1–2% real return, at times even lower.

So, if you must increase your wealth in the long run, equity is preferable. If you must keep money for immediate expenses, debt is better.

How Are Mutual Funds Taxed In 2025?

Equity mutual fund tax rules are different from tax on debt mutual funds. 

1. Equity Funds:

• If you redeem equity mutual funds within 12 months, your profits are taxed at 15%.
• If you have held them for over 12 months, profits over INR 1 lakh a year are taxed at 10%.
• There is no indexation benefit. But equity funds still enjoy lower tax rates on long-term investors.

2. Debt Funds: 
Prior to April 2023, long-term gains on debt funds were taxed. All gains now—both long-term and short-term—are taxed at your slab rate of income.
Therefore, if you are in the 30% tax slab, your gains in debt funds are taxed at 30%, along with cess.

Here is a quick comparison table:

Let us compare two investors. Each puts INR 1 lakh in a mutual fund for one year.

• Equity Fund:
  • Return = INR 15,000
  • Tax = 15% of INR 15,000 = INR 2,250
  • Net Gain = INR 12,750? Net Return = 12.75%
• Debt Fund:
  • Return = INR 6,000
  • Tax = 30% of INR 6,000 = INR 1,800
  • Net Gain = INR 4,200? Net Return = 4.2%

The net gain after taxes is higher in the case of equity funds compared to debt funds. 

Understanding Risk, Access, And Suitability 

Here is how risk and liquidity vary for equity and debt mutual funds:

• Risk: Equity funds have greater market risk. They go up and down sharply. Debt funds have credit risk and interest rate risk, but on the whole, they are more stable. Equity funds are more suitable for risk-seeking investors with a long-time horizon. 
• Liquidity: The majority of equity and debt funds are redeemable in 1–3 business days. Liquid debt funds have the option of same-day payment. Those who are looking for highly liquid funds must understand the payment options available to make the right choice. 

Who Should Invest?

Choosing The Right Fund: Step-by-Step Guide 

Some of the factors you must consider while choosing between equity vs debt mutual funds are:

1. Begin with your objective: Want cash in 1–2 years? Choose a debt fund. Planning for retirement or buying a house in 10 years? Go for equity funds with a long-term horizon. 
2. Understand your risk tolerance: Can you withstand market fluctuations? Opt for equity. Otherwise, take debt or balanced funds.
3. Compare return, risk, and expense: Utilise Sharpe ratio, standard deviation, and expense ratio to compare funds. Each mutual fund scheme varies based on the risk exposure and return potential. Compare multiple options to choose a scheme.
4. View the fund's historical performance: See how it performed in good and bad times. Look beyond the last 1 year. This can help you understand the fund's performance, especially with a longer time horizon. 
5. Understand the portfolio: See what the fund holds. Do not take high-risk bonds or over-concentrated equity positions.
6. Check exit load and lock-in: Select low or zero exit load funds if liquidity is needed.
7. Rebalance annually: Check your composition annually. Rebalance if necessary.

Can Hybrid Funds Be a Middle Path?

Hybrid funds combine equity and debt. They provide higher returns than exclusive debt and more stability compared to pure equity.

You receive:

• Smoother returns
• Automatic rebalancing
• One fund for all objectives
• Balanced advantage funds and aggressive hybrid funds are suitable for investors with moderate risk.

How To Invest In Mutual Funds: SIP or Lumpsum?

Once you have chosen between equity and debt mutual funds, the next step is deciding how to invest. The two most popular methods are Systematic Investment Plans (SIPs) and lumpsum investments.

Each has its own advantages depending on your financial situation and market conditions.

1. SIP (Systematic Investment Plan)

• SIPs allow you to invest a fixed amount regularly, usually monthly.
• Ideal for salaried individuals or those with consistent income.
• Helps in rupee cost averaging, which reduces the impact of market volatility.
• Highly recommended for equity mutual funds, especially if your goal is long-term.

Benefits of SIPs:

• Encourages disciplined investing
• Removes the need to time the market
• Great for long-term wealth creation

2. Lumpsum Investment

• A lumpsum investment means putting in a large amount in one go.
• Works well for debt mutual funds or during market corrections.
• Best suited when you have idle money like bonuses or proceeds from an asset sale.

When to use lumpsum:

• If markets are low and you want to capitalise on potential recovery
• If you have a short-term financial goal, like a planned expense in 1-3 years

3. Which Mode Should You Choose?

Conclusion

The decision between equity and debt is based on what you are aiming for, how long you have to hold onto it, and your risk-taking capacity. Equity funds make money but are subject to fluctuations. Debt funds are safe but provide limited growth.

Base your decision on your investment goals and income tax slab. Review your fund options annually. An astute combination can lead to having the best of both worlds.

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FAQs On Equity Vs Debt Mutual Funds

1. When should I invest in debt funds as against equity funds?

If your target is less than 3 years away, pick debt. For targets over 5 years, equity is optimal for better wealth building.

2. Are equity mutual funds riskier than debt mutual funds?

Yes. Equity funds come with market risk. Debt funds are less risky but come with interest rate and credit risk.

3. Can hybrid funds provide the best of equity and debt?

Yes. Hybrid funds provide growth and protection in one package. They are best suited for investors with medium risk appetite.

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