Balanced Fund vs Debt Fund

Balanced funds typically offer higher returns than debt funds but lower returns than equity funds. This is because the returns from balanced funds depend on the asset distribution ratio between debt and equity investments.
Balanced Fund vs Debt Fund
3 min
26-July-2024
Investing is considered the core of an effective financial plan that builds wealth over time and ensures that you have adequate funds when you need them the most. However, when it comes to investing, new investors are often confused as to where they should invest. Most new investors have a low-risk appetite and want to invest in investment instruments with lower risk but can still offer good returns. One of the most popular low-risk investment instruments is a mutual fund, which pools investor’s money to invest in a host of securities, offering diversification and good returns.

However, when investing in mutual funds, investors have to decide which type of scheme they want to invest in and allocate their funds. This is because many types of mutual funds have different asset allocations, return potential, and risk appetites. Two of the most popular mutual fund schemes are balanced funds and debt funds.

This article will help you understand the difference between balanced funds and debt funds so that you can choose the most suitable one for you or create a mixed investment strategy.

What are balanced funds?

Balanced funds are a type of mutual fund with a hybrid structure that invests the investor’s money in two or more asset classes. The most common asset classes within balanced funds are equities and debt. The amount that such funds invest in each asset class is predefined in the fund prospectus and must remain within the set asset allocation limits. Balanced funds ensure investors can diversify the invested amount between equities and debt instruments to lower the overall risk.

While equity investments are considered risky, the debt instruments in a balanced fund provide a cushion for squaring off the potential losses made in equity investments. On the other hand, equity investments also provide higher profit potential, maintaining an effective balance between risk and reward.

Balanced funds can have different asset allocation ratios even with the same asset classes. For example, a balanced fund scheme may invest 80% of the amount in equities and the remaining 20% in debt instruments, while a different balanced fund scheme may invest 60% in equities and 40% in debt instruments. The allocation is based on the investment goals set by the portfolio manager for a specific balanced fund scheme.

What are debt funds?

Debt mutual funds are types of mutual funds that invest in fixed-income securities that offer fixed returns to investors at regular intervals. They primarily invest in fixed-income investment instruments such as corporate bonds, treasury bills, commercial papers, and other instruments related to the money markets. The investment instruments included in a debt fund have a predetermined maturity date and a set interest rate based on which they offer interest payments to the investors.

Debt funds are not connected to market conditions as the included securities are not market-linked. Hence, their returns are fixed and witness negligible volatility. Every security included in a debt mutual fund comes with a credit rating, which defines the ability of the issuer to pay regular interest and repay the principal amount at maturity. The higher the rating, the lower the risk attached to a debt mutual fund.

Debt mutual funds are ideal for investors who want to earn steady returns at a lower risk without the potential of capital appreciation. Unlike balanced funds, where only a portion of the funds is invested in debt securities, debt funds invest a higher portion in debt securities to make the scheme one of the most low-risk. The debt fund's Net Asset Value (NAV) depends on the interest rates of the included securities and the gradation and upgradation of the securities’ credit ratings.

Comparative analysis of balanced funds and debt funds

Here is a comparative analysis of balanced funds vs debt funds:

Investment objective

Balanced funds have an investment objective of both capital appreciation through equity investments and fixed income from debt investments. However, debt funds only focus on the generation of regular fixed income.

Asset allocation

Balanced funds maintain a mix of equity and debt, whereas debt funds primarily invest in fixed-income instruments like bonds, government securities, etc.

Risk profile

Balanced funds carry moderate to moderately high risk due to their equity exposure, whereas debt funds are considered low-risk investments.

Return potential

Balanced funds offer higher potential returns than debt funds because of their equity investments. On the other hand, debt funds generally provide lower but stable returns.

Volatility

Balanced funds witness higher volatility as their equity investments fluctuate due to market conditions. However, debt funds witness low or negligible volatility as the debt instruments are not market-linked.

Taxation

Balanced funds are taxed based on the asset allocation in equity and debt instruments, while debt funds are taxed based on the holding period.

Liquidity

Balanced funds may offer lower liquidity at the time of a bearish stock market. On the other hand, debt funds are generally more liquid.

Investment horizon

Balanced funds are suitable for medium—to long-term investments, while debt funds are more suited to short—to medium-term goals.

Suitability

Investors with a moderate risk appetite looking for growth potential may prefer balanced funds, whereas investors seeking stable income with lower risk may opt for debt funds.

Expense ratio

Balanced funds generally have a higher expense ratio as they are actively managed, while debt funds have a lower expense ratio because of passive management.

Here is a detailed table describing the difference between balanced funds and debt funds:

Aspect Balanced fundsDebt funds
Investment ObjectiveGrowth through equities and income through debtIncome through debt
Asset allocationMix of equity (usually 65-75%) and debt (25-35%)Most of the investment in debt securities
Risk profileModerate to moderately highLow
Return potentialHigher potential returns compared to debt fundsGenerally lower returns compared to balanced funds
VolatilityHigher due to equity exposureLow and stable
TaxationTCG tax after 1 year, STCG tax before 1 year for the equity portionLTCG tax after 3 years and indexation benefit for the debt portion
LiquidityGenerally liquid but subject to market conditionsHigh liquidity and easy to redeem
Investment horizonMedium to long-term (3-5 years or more)Short to medium-term (1-3 years)
SuitabilityInvestors with moderate risk tolerance seeking growthInvestors seeking stable income with lower risk tolerance
Fund management Active management to balance equity and debtPassive management focused on fixed-income


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Who can invest in balanced funds?

Balanced funds carry moderate risk because of their equity investments. However, the equity component significantly increases the return potential of the fund scheme. Hence, investors who can take moderate risk and want to earn both from capital appreciation and fixed-income instruments can invest in balanced funds. Long-term investors who are looking to invest in the medium to long term can also invest in balanced funds as there are more chances for the market to stabilise in case of any bearish trend negatively impacting equity investments.

Hence, if you have a higher risk appetite and want to earn better returns than those of fixed-income instruments while also lowering the risk attached to equity funds, you can invest in balanced funds for capital appreciation and fixed income.

Who can invest in debt funds?

Debt funds majorly invest in fixed-income securities that are not market-linked but offer a regular income through interest payments. The rate of interest and the maturity period are predefined, allowing investors to know how much they stand to earn along with the time period. Since debt funds do not have any equity component, they witness negligible volatility and contain a very low risk of losses. The only time investors can make losses is when the issuer of the debt security defaults on payments. However, investors can also lower this risk of default by choosing a debt fund with a higher credit rating.

Hence, debt funds are suitable for investors whose main focus is to avoid losses, maintain their investment value, and earn steady returns from regular interest payments. Investors who do not aim to earn through capital appreciation but want to earn income through regular interest payments can invest in debt funds. Furthermore, debt funds are suitable for investors looking to invest in the short to medium term.

Balanced fund vs. debt fund - Which is better?

Determining whether balanced funds or debt funds are better depends entirely on an individual’s financial goals, risk tolerance, and investment horizon.

Balanced funds can be an ideal option for investors who want to earn from both capital appreciation (equities) and interest payments (fixed-income). Although balanced funds offer lower returns than equity funds, they are ideal for investors who have a moderate risk appetite and want to earn better returns than a debt fund. However, the presence of equities introduces higher volatility, making balanced funds less ideal for short-term goals. Additionally, the taxation of balanced funds can be more complex, involving both equity and debt tax rules.

On the other hand, debt funds primarily invest in fixed-income instruments such as bonds and government securities. These funds are specifically designed to provide regular income with lower risk and volatility than balanced funds. Debt funds are suitable for conservative investors who want stable returns and higher liquidity. Investors choose debt funds to achieve their short—to medium-term financial goals, prioritising capital preservation and regular income over growth. Furthermore, debt funds also offer indexation benefits, making them tax-efficient for investors with a holding period of more than three years.

In conclusion

Balanced funds offer better returns due to their mix of equity and debt investments, while debt funds offer lower returns but with a lower risk exposure. Investors with a moderate risk appetite and want to earn more through equity investments in the medium to long term can choose balanced funds. On the other hand, investors who prioritise capital preservation over growth and want to earn steady returns in the short to medium term can choose debt funds. However, most experienced investors create a mix of both funds, allocating a portion to balanced funds while investing the remaining in debt funds for better diversification and returns.

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Frequently asked questions

Is balanced fund a debt fund?
No, balanced funds are not debt funds but hybrid funds that have equity and debt instruments included as a part of their asset allocation.

Are balanced funds a good idea?
Yes, balanced funds are a good idea as they create a balance between equity and debt investments. While equity investments offer a higher return potential, debt instruments lower the overall risk by offering fixed and steady returns.

Are balanced funds tax-free?
No, balanced funds are not tax-free, and equity-oriented balanced funds are taxed as per equity fund taxation rules, while debt-oriented funds are taxed as per the debt fund taxation rules.

What is the interest rate of a balanced fund?
There is no fixed interest rate for balanced funds, and their returns are determined based on market fluctuations and the performance of the included securities.

Which is better—equity or balanced fund?
Equity mutual funds may offer higher potential returns but have significant risks. On the other hand, balanced funds create a balance between risk and reward and offer returns based on both equity and debt investments.

Do balanced funds pay dividends?
Yes, the balanced fund may provide dividends if the equities included in the fund have announced dividends.

Are balanced funds a good investment?
Yes, balanced funds can be an ideal investment for investors with moderate risk appetite who want to invest for the long term and earn through capital appreciation and fixed income.

Is a debt mutual fund tax-free?
No, debt mutual funds are not tax-free. They are subject to capital gains tax. Short-term capital gains (holding period less than 3 years) are taxed at the investor's applicable income tax rate. Long-term capital gains (holding period of 3 years or more) benefit from indexation and are taxed at 20% after indexation.

Is a balanced fund safe?
Yes, balanced funds are safe investments as they offer a balanced approach with a mix of equity and debt investments. However, as they contain moderate risk, it is important to invest after due diligence.

Do balanced funds provide a fixed income?
No, balanced funds do not provide a fixed income. They invest in both equities and debt instruments, aiming for a combination of growth and income. The returns can vary based on market performance and the fund's asset allocation.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

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