The main difference between debt fund and equity fund is that debt funds have considerably lesser risks compared to equity funds. The other major difference between debt mutual fund and equity mutual fund is that there are many types of debt funds which help you invest even for one day to many years.
Debt funds are better for short-term investments because of their lower risk and potential to offer relatively stable returns, while equity funds are more suited for long-term investments as they entail higher risk but offer higher return potential in the long term.
Some of the major risks in these instruments/funds are: 1) Interest risk- This is also known as price risk. Whenever there is a change is the interest rates the price of a debt instrument also changes.
Equity is selling a piece of the company for money with an expectation that you'll share some of the profits with the equity holders in the form of dividends. Since debt is contractually agreed, it is considered safer because a company will pay its debts first (it has to).
Unlike equity financing, where you give up a portion of your business in exchange for capital, debt allows you to grow without diluting your ownership stake. This means you retain decision-making power and control over your company's direction.
However, investment in a dynamic bond fund for an equal tenure will offer higher returns than the bank FD. Investors also have the option of a Monthly Income Plan if they want monthly payouts akin to interest on FDs.
Overnight Funds
These overnight instruments are backed by collateral which comprises of Government Securities, and so these funds also have no credit risk. These are the safest debt funds but their yield is usually also the lowest. Overnight funds are suitable for parking your funds for a few days.
The safety of debt funds depends on the type of debt funds and the interest rate fluctuations. Long-term debt funds may give negative returns when interest rates are rising. Short-term debt funds offer a lower return when interest rates fall. Credit risk funds invest your money in bonds of a lower rating.
Liquidity: Debt funds feature high liquidity, with speedy redemption, usually within one or two working days. Unlike fixed deposits, there's no lock-in period, but some funds may impose minor exit costs for early withdrawal.
Debt financing is generally considered to be less risky than equity financing because lenders have a legal right to be repaid. However, equity investors have the potential to earn higher returns if the company is successful. The level of risk and return associated with debt and equity financing varies.
If you plan to invest to meet a long-term need and can handle a fair amount of risk and volatility, a long-term capital appreciation fund may be a good choice. These funds typically hold a high percentage of their assets in common stocks and are, therefore, considered to be risky in nature.
Unlike Equity Funds, Debt Funds are considered low risk and are ideal for conservative investors seeking stable returns. They offer liquidity, ease of investment and diversification across various debt instruments. However, Debt Funds are subject to interest rates and credit risk.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
Generally, debt funds are considered safer than equity funds because they primarily invest in fixed-income securities with lower volatility. However, the level of safety depends on the credit quality and maturity of the underlying securities.
On the other hand, a low Debt-to-Equity Ratio means the company relies more on equity financing than debt. This is generally seen as a safer investment, as the company is less burdened by debt repayments. Companies with a Debt-to-Equity Ratio of around 1.0 to 2.0 are often considered to have a healthy balance sheet.
There won't be much impact on debt funds if the equity market crashes because the dynamics of the fixed-income market are very different. What has a bearing on debt funds is the general state of the economy and inflation rates. If inflation goes up, interest rates go up. Bonds are hit if interest rates go up.
Bond prices and interest rates have an inverse relationship; when interest rates fall, bond prices go up. This results in appreciation of the bond value that the debt funds hold which, in turn, leads to higher returns.
Yes, most debt funds allow withdrawals anytime without incurring an exit penalty. Additionally, you can set up a Systematic Withdrawal Plan (SWP) to automate monthly withdrawals from your funds.
They stay away from debt.
Car payments, student loans, same-as-cash financing plans—these just aren't part of their vocabulary. That's why they win with money. They don't owe anything to the bank, so every dollar they earn stays with them to spend, save and give! Debt is the biggest obstacle to building wealth.
These risks include Credit risk, Interest rate risk, Inflation risk, reinvestment risk etc. But the key risks which needs be considered before investing in Debt funds are Credit Risk and Interest Rate Risk; Credit Risk (Default Risk):
The Pradhan Mantri Vaya Vandana Yojana (PMVVY)
The plan provides a fixed rate of return of 7.4% per year for ten consecutive years. One of the best options for risk-averse investors to get ₹10,000 per month as a pension is investing in the PMVVY scheme.