Choosing between equity and debt mutual funds: Which one is right for you?

While equity have usually been the main focus for many investors, it's a good idea to think about adding some debt investments to your mix.

When it comes to mutual funds, it can be tough to decide which one suits you best. There are different types, like ones focused on stocks, debts, or a mix of both. Before picking a fund, it's crucial to think about how much return you expect and how much risk you're comfortable with.

Traditionally, Debt Funds were favoured by risk-averse investors due to their stable returns and minimal risk compared to inflation. However, changes in tax rates introduced in the Union Budget 2023-24 have caused investors to reconsider their options.

Post April 1, 2023, debt funds are subject to a stricter tax regime. Gains from "specified mutual funds" (those with less than 35 per cent equity exposure) are now taxed as short-term capital gains based on the investor's income slab rate, which can reach as high as 30 per cent. Additionally, after three years, debt funds face a 20 per cent long-term tax rate without any inflation-adjusting indexation benefit, which was previously advantageous for long-term investors. These changes, initially aimed at creating a fairer landscape for direct investments, have inadvertently tilted the scale towards equity investments.

In contrast, equity investments have a notable advantage: short-term capital gains are taxed at a manageable 15 per cent, and long-term gains exceeding Rs 1 lakh are taxed at a mere 10 per cent. While both equity and debt offer opportunities for wealth creation, this tax disparity may incentivize risk-averse individuals to pursue equity returns primarily for tax benefits, potentially leading to a preference for equity as the easier option.

However, opting for short-term equity gains solely driven by tax benefits poses risks and may hinder long-term wealth creation. This approach might overlook diversified portfolios featuring low-risk, tax-efficient instruments like balanced funds or tax-free bonds, possibly resulting in significant losses.

Debt funds:

More people are getting into mutual funds, and it's a good idea to think about adding some debt to your investments. Here are a couple of things the government is doing to help with that:

First, the SEBI (Securities and Exchange Board of India) has made it easier for regular investors to invest in corporate bonds. They've lowered the minimum amount you need to invest to just Rs 1 lakh. They're also keeping an eye on online platforms to make sure they're safe for investors.

They've also changed the way you can buy bonds. Now, there's something called the Request for Quote (RFQ) process, which lets regular investors like you buy a wider range of bonds, including ones from companies and the government. This gives you more options and helps you manage your risk better.

And finally, there are online platforms that make it simple for anyone to invest in bonds. They cut out the middlemen and make the whole process easier to understand.

Investing in debt means you can count on getting regular payments over time, which helps you stick to your long-term money goals and keeps things stable. Your initial investment is pretty secure because you usually get it back after a set period, so you're not likely to lose much money. This helps you balance out any ups and downs in the market and makes your overall investment mix safer.

Conclusion:

In simple terms, debt investments aren't just for people who don't like taking risks anymore. They're actually becoming a popular choice for balancing out your investment mix. While equity have usually been the main focus for many investors, it's a good idea to think about adding some debt investments to your mix.

Disclaimer: The article is for informational purposes only and not investment advice.