Equity Fund or Debt Fund: Which is better while investing for financial freedom?

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© Provided by The Financial Express There are lots of factors to consider before deciding which category of mutual funds to invest in.

Debt Mutual Funds vs Equity Mutual Funds: The purpose of saving money is to meet our financial goals in life. Savings translate into investments when you earmark them towards a goal with the objective of earning a higher return. The stage in your life when you have accumulated adequate savings or assets that can help you sustain your living expenses without having to depend on any regular income is what is called financial freedom. Needless to say, your life goals such as children’s education, marriage, home buying will have to be met before you achieve that stage. To meet your long-term goals, the role of two asset classes are prominent – equity and debt. It’s the combination and the optimum usage of both of these assets that will help you achieve financial freedom in your life. There are several other aspects of financial freedom. Here we touch upon the investing part of it. And, with most of us, especially those who are young, this is possible by making use of equity funds and debt funds.

But, if you start with asking which is a better debt fund or equity fund, the beginning will not be in the right way. Both, debt and equity funds have different roles to play. “As a lay investor, one person needs to understand their objective. If the objective is high return and the investor is willing to take high risk in equity. If the idea is to protect capital then debt is the option. It depends on the personal objective and age. I would recommend lower the age, higher the risk should be there because in the long run, equity will surpass returns in terms of all asset classes whereas when the age is very high like above 50 or so then the debt should be the preferred option because at that point of time, we should not play around with the hard-earned money,” says Rachit Chawla, CEO & Founder, Finway FSC.

Mutual fund schemes that invests at least 65 per cent of investor’s funds into the equity shares of companies are called equity mutual funds. The returns from such funds with equity as its underlying asset are volatile in nature and hence ideal for long-term investing. Debt funds invest in fixed income instruments such as government securities or corporate bonds. In addition to any capital appreciation they also earn interest from the fixed income securities that they are invested in.

Equity funds work well over long term while debt funds suit short to medium term goals. Your own risk appetite also needs to be considered but ideally if you are young, opt for equity funds. Retired and senior citizens also need exposure in equity funds to take care of inflation but a lower exposure than youngsters will suffice. “There are lots of factors to consider before deciding which category of mutual funds to invest in.

According to Col. Sanjeev Govila (Retd), a SEBI Registered Investment Advisor (RIA), and CEO, Hum Fauji Initiatives, a financial planning firm, following should be the main criteria as also the order in which they should be considered:

1. Own risk profile-how much volatility of returns is acceptable.

2. Future financial requirements (goals)-For long term goals, typically 5 years and beyond, equity is the best bet while for shorter goals, debt should be looked at.

3. Current market conditions-general market and stock-specific valuations as also the interest rate scenario are important.

“Broadly, a combination of the above three will decide what combination of equity and debt is the best for a particular person. Also in deciding so, one should take a portfolio approach rather than this-or-that approach. Typically, all portfolios will have Equity, Debt and hybrid funds in various measures,” adds Col. Govila (Retd).

Once you are nearing the goals, it’s better to de-risk from equities to less volatile debt funds. You may start shifting from equity funds to debt funds about three years away from goals to preserve the accumulated amount. Although investing in a mutual fund is less risky than investing in the capital market directly, it is not risk-free. Therefore, do not be casual while selecting a mutual fund scheme, especially if you are in for the long haul.