Mutual funds have become a popular option for investment over the last few years for various reasons. In fact, the capital you invest is every much like a pot of gold, wherein which, with the right investment, strategy, market conditions and asset investment, you can get good returns.
But what happens when you don’t invest this pot of gold in the right option? You learn the same lesson that the miser learnt when he invested his pot of gold in nothing but a corner of his garden grounds.
The tale of the miser and his hidden pot of gold is quite the folklore. The miser, who didn’t want to spend a single coin of gold, hid the pot in particular spot of his garden, where each and every day, he would count his coins to see if they were all there. A well observant thief noticed this behaviour and spotted the pot of gold as the miser dug it up to count the coins on one single day. Having discovered this unexpected treasure, the thief secretly dug out the gold and stole the gold away, much to the grief of the miser. But it was a passerby, who on learning the dilemma of the miser, provided the ultimate words of wisdom. “Pray do not grieve so. Take a stone and place it in the hole. The stone will do you quite the same service; for when the gold was there, you had it not, as you did not make the slightest use of it.”
As you can see, investing your pot of gold in the right investment option is crucial. You do not want to be in a position where you invest your gold in a possibility, equivalent to a hole in a ground and get returns that are equivalent to the value of a worthless stone. But imagine if you invest your pot of gold that offers good returns, efficient protection, with multiple schemes and matches your end goal, no matter how long the investment tenure.
Investing in mutual funds will offer you these benefits. With the right market conditions, investment strategy, choice of scheme and tenure, you can get more gold coins than the pot of gold you had initial investment. But like any other investment option, choosing your best mutual funds is a challenging task, but a rewarding one once you get the right investment option.You need to need to know the risks of investing, the understanding of tools and techniques, the fundamental research, analysis required and the understanding of market trends and forecast.
But first, you need to know the difference between investing in debt mutual funds and equity mutual funds. While they both come under the same umbrella as mutual funds, they have considerable differences. By understanding these key differences, you will be able to understand which mutual fund investment scheme will work for you.
Key differences between debt and equity mutual funds
- Low in risk: Debt mutual funds are considered to be lower in risk. That is because they invest in instruments that yield a fixed income. These instruments include government bonds, company debentures, commercial paper and company fixed deposits.
- Fixed returns: They do not offer guaranteed returns, they offer a relatively more certain return.
- Tax efficiency: After one year of investment, the income from a debt fund is treated as a long-term capital gain and is taxed at either 10% or at 20% after indexation. This indexation includes the cost of investment raised to account for inflation for the length of the period for than 3 years. In other words, the longer you hold a debt fund, the bigger is the indexation benefit.
- Essential asset class: Equity mutual funds are an essential asset class for the long-term growth of savings.
- Long-term investment: The investment period can be more than 7 years to 40 years.
- Returns: The returns you get with the asset class are designed to beat inflation as they invest in stocks of companies and have proven to provide an inflation-beating return in the past.
How to decide between debt and equity mutual funds
The miser made his choice and bore the brunt of his decision. You too have a choice, but to ensure that you get the most of The miser made his choice and bore the brunt of his decision. You too have a choice, but to ensure that you get the most of your mutual fund investment option. If you are planning to invest in MF, you need to see which option suits you the best:
Objectives: You may want to generate income, or create wealth through mutual funds. If you want to opt for income generation, mutual debt fund is advisable, as it provides more certainty of return. For growth and wealth creation, equity mutual funds make for a better option.
Duration: You should select the asset class, based on the end tenure where you would require the funds. Debt funds are best for a short duration, say of 5 to 7 years. Equity funds can be held more than 7 years to 40 years.
Returns expected: Each asset class comes with their own set of risk levels and uncertainty. Returns for debts are of 9% on a long-term average basis, whereas equity returns are 16%.
Risks involved: The risks involved should be in line with your objective and return expectations. The variants of returns in debt are usually small for a long-term average. This means that there will be a high degree of certainty in terms of the returns for the long-term average. Moreover, the risk of capital loss is also very low. Equity returns, on the other hand, vary in the broad range. However, it also has a high-risk capital loss. Nevertheless, longer the holding period, the more narrower will be the range of return variants.
Applicable for tax: Debt funds attract short-term capital gains tax before three years and long-term capital gains with indexation after three years. Equity investments on the other hand, are highly tax efficient, with zero tax for holdings longer than 1 year. However, there is no difference in tax between equity and debt when it comes to investing longer than three years.