Equity Mutual Funds vs Debt Mutual Funds - Which Suits Your Goals

​"Should I put my bonus in equity or debt funds?"

This question lands in our WhatsApp community almost daily. And honestly, it's the wrong question to start with.

The right question is simpler: When do you need this money?

That single answer determines whether equity or debt makes sense for you. Everything else follows from there.

Here's why this matters more than ever in 2025. The RBI has cut repo rates twice this year, from 6.5% to 5.5%, pushing debt fund returns higher than they've been in years. (Gripinvest) 

Meanwhile, equity markets have been volatile. Small caps fell 7%, mid caps barely broke even, while large caps managed modest 6-10% gains. (Outlook Money)

The tax rules also changed dramatically in 2023 and 2024, completely flipping which category is more tax-efficient for whom.

At Belong, we've spent years helping NRIs navigate these decisions. What we've learned: Most people don't need to choose between equity and debt. They need both, but in proportions based on when they'll actually use the money.

This guide covers everything: how each category works, realistic returns, tax implications, risks you should know, and a practical framework for deciding your allocation. By the end, you'll know exactly what belongs where.

Why This Decision Matters More for NRIs

Before we compare the two categories, let's acknowledge why this decision feels harder for NRIs than for resident Indians.

You're earning in dirhams or dollars. Your investments are in rupees. The rupee has depreciated 3-4% annually against the dollar over the past decade. (RBI) So even if your investment grows 10% in INR, your real return in home currency might be 6-7%.

Add volatility on top of currency depreciation, and short-term equity losses can feel brutal. An equity fund that crashes 30% in rupees might be down 33-35% in dollar terms if the rupee also weakens.

This is why many NRIs in our community lean toward debt funds for money they'll need within 5 years. The stability helps them sleep at night. But for longer horizons, equity's higher returns typically compensate for both volatility and currency depreciation.

👉 Tip: Think of debt funds as your stability anchor and equity funds as your growth engine. Most portfolios need both, but in different proportions based on your timeline.

What Exactly Are Equity Mutual Funds?

Equity mutual funds pool money from investors and invest primarily in company stocks. When you buy units, you're essentially buying tiny pieces of dozens or hundreds of companies.

SEBI mandates that equity-oriented funds must invest at least 65% of their assets in equity shares of domestic companies. (SEBI) The remaining 35% can go to debt instruments or cash, giving fund managers some flexibility during volatile markets.

Types of Equity Funds:

• Large cap funds: Invest in India's top 100 companies by market value. These are established giants like Reliance, TCS, and HDFC Bank. Lower risk within equity, but also lower growth potential.

• Mid cap funds: Invest in companies ranked 101-250. These are growing businesses with room to become large caps. Higher volatility, higher potential returns.

• Small cap funds: Companies ranked 251 and below. Highest growth potential but also highest volatility. Can swing 40-50% in a year.

• Flexi cap funds: Freedom to invest across all market caps based on fund manager's judgment. A one-fund solution for diversified equity exposure.

• Sectoral/thematic funds: Focus on specific industries like banking, IT, pharma, or infrastructure. High concentration risk.

Your returns come from two sources: stock price appreciation and dividends. But both depend heavily on how companies perform, how the economy does, and how investors feel about markets.

What Exactly Are Debt Mutual Funds?

Debt mutual funds invest in fixed-income securities like government bonds, corporate bonds, treasury bills, and money market instruments. When you invest in a debt fund, you're essentially lending money to governments or corporations. They pay you interest, and you get your principal back at maturity.

Unlike equity, where returns depend on company profits and market sentiment, debt returns come from interest earned on underlying securities plus any capital gains from bond price movements.

Types of Debt Funds:

• Liquid funds: Invest in securities maturing within 91 days. Ideal for emergency funds or short-term parking. Almost no volatility.

• Ultra-short duration funds: Slightly longer maturities, 3-6 months. Marginally higher returns than liquid funds.

• Short-term and medium-duration funds: Maturities from 1-4 years. Balance of returns and stability.

• Corporate bond funds: Invest at least 80% in high-rated corporate debt. Slightly higher yields than government securities.

• Gilt funds: Invest only in government securities. Zero credit risk since the government won't default. But highly sensitive to interest rate changes.

• Dynamic bond funds: Fund managers actively adjust duration based on interest rate outlook. Can benefit from rate cycles if managed well.

The key concept to understand: When interest rates fall, existing bonds become more valuable (their prices rise). When rates rise, existing bond prices fall. This inverse relationship drives much of debt fund volatility.

👉 Tip: Gilt funds have zero credit risk but high interest rate risk. Corporate bond funds have both credit risk and interest rate risk. Liquid funds minimize both but offer lowest returns.

Returns Comparison: What Should You Realistically Expect?

Let's look at actual numbers instead of marketing promises.

Long-Term Average Returns (5-Year CAGR):

(Groww, INDmoney)

2025 Performance (A Reality Check):

The year 2025 has been humbling for equity investors and surprisingly good for debt:

Equity:

• Flexi cap average: 2.7% (Outlook Money)
• Mid cap average: 1.9%
• Small cap average: -4.4% (worst year in seven)
• Large cap: 6-10%

Debt:

• Medium duration funds: 8.7% average one-year return
• Corporate bond funds: 8%+
• Liquid funds: 6.7-7.1%

(Business Standard)

Why did debt outperform this year? RBI cut repo rates by 100 basis points total in 2025, from 6.5% to 5.5%. (ICICIdirect) When rates fall, existing bonds with higher yields become more valuable. Long-duration and gilt funds saw NAV increases as bond prices rose.

The Longer View:

Over 10-15 year periods, equity has historically delivered 12-15% CAGR versus 7-8% for debt. But equity comes with years like 2008 (-52%), 2011 (-25%), and 2020's brief crash (-38%). If you can ride these out, equity rewards patience. If you panic and sell during crashes, you lock in losses.

The 2025 Tax Reality: A Game-Changer for Debt Funds

Tax rules changed significantly in 2023 and 2024. If you're making investment decisions based on old tax information, you might be making expensive mistakes.

Equity Fund Taxation (FY 2025-26):

• Short-term capital gains (held under 12 months): 20% flat rate
• Long-term capital gains (held over 12 months): 12.5% on gains above Rs 1.25 lakh per year

(Income Tax Department, Finnovate)

The Rs 1.25 lakh exemption is per financial year, not per fund. If you redeem from multiple equity funds, the exemption is shared across all.

Debt Fund Taxation (The Big Change):

For investments made on or after April 1, 2023, there is NO long-term/short-term distinction. All gains are taxed at your income tax slab rate, regardless of how long you hold.

(Gripinvest, Bajaj Finserv)

For older investments (before April 2023) sold after July 23, 2024:

• Gains on holdings over 24 months: 12.5% without indexation
• Gains under 24 months: Your slab rate

What This Means Practically:

If you're in the 30% tax bracket:

• Equity LTCG: 12.5% (after exemption)
• Debt fund gains: 30%

A 7% debt fund return becomes roughly 4.9% post-tax for high earners. An equity fund with 12% returns (if held long-term) keeps about 10.5% after LTCG tax.

This tax change has tilted the math significantly toward equity for long-term investors in higher brackets. The tax advantage debt funds once had through indexation is gone.

NRI-Specific Tax Points:

For NRIs, TDS adds another layer:

• Equity: 20% TDS on STCG, 12.5% TDS on LTCG
• Debt: 30% TDS on capital gains
• Dividends: 20% TDS on debt fund dividends (subject to DTAA)

(SBNRI)

You can claim refunds by filing an ITR if TDS exceeds actual liability.

👉 Tip: Use Belong's NRI tax filing service to ensure you're claiming all eligible refunds. Many NRIs overpay because they don't file returns.

Risk Profiles: Understanding What You're Actually Signing Up For

Returns only tell half the story. Risk defines the journey.

Equity Fund Risks:

• Market risk: Stock prices fall during recessions, crises, or sentiment shifts. During COVID-19 (March 2020), many equity funds fell 35-50% in weeks.

• Volatility: Daily swings of 1-3% are normal. Some years bring 40% gains followed by 20% losses. This is the price of higher long-term returns.

• Recovery time: After major crashes, recovery can take years. Post-2008, many funds took 4-5 years to recover previous highs.

Debt Fund Risks:

• Interest rate risk: When RBI raises rates, existing bond prices fall. Long-duration funds are most affected. In 2022, when RBI hiked rates, debt fund returns dropped from 8-10% to 2-3%. (1Finance)

• Credit risk: If a company whose bonds the fund holds defaults, you lose money. Remember IL\&FS in 2018? Several debt funds took massive hits. Franklin Templeton's 2020 fund shutdown showed even established fund houses aren't immune.

• Liquidity risk: In stressed markets, bonds can become hard to sell at fair prices.

Comparative Risk Table:

How Your Investment Timeline Should Drive Your Decision

Your time horizon is the most important factor. Everything else, including risk tolerance, secondary.

Under 1 Year (Emergency Fund, Planned Expenses):

Use liquid funds or ultra-short duration funds. You need stability and quick access. Equity volatility is unacceptable for money you might need tomorrow.

Expected returns: 6-7%

1-3 Years (Car Purchase, Wedding, Down Payment):

Primarily debt funds. Short-term or medium-duration funds offer better returns than liquid with manageable volatility. Maybe 10-20% in large cap equity if you can stomach short-term swings.

Expected returns: 6.5-8%

3-5 Years (Child's Education Deposit, Near-Term Goals):

Mix of debt and equity. Perhaps 60% debt, 40% equity. The equity portion has time to recover from one bad year. The debt portion protects against severe losses.

Expected returns: 8-10%

5-10 Years (Major Life Goals):

Tilt toward equity. Perhaps 60% equity, 40% debt. Time smooths equity volatility. You can ride out one or two bad years.

Expected returns: 10-14%

10+ Years (Retirement, Long-Term Wealth):

Primarily equity with some debt for rebalancing. 70-80% equity is reasonable for truly long-term money. The math strongly favors equity over such periods.

Expected returns: 12-15%

👉 Tip: Never invest money you'll need within 2 years into equity. A 30% crash right before you need the funds can derail your entire plan.

The 2025 RBI Rate Cut Opportunity: Why Debt Funds Are Attractive Now

Let's talk about timing, specifically for debt funds in the current environment.

The RBI has cut repo rates from 6.5% to 5.5% in 2025. (Business Today) When rates fall:

1. Existing bonds in fund portfolios become more valuable (their prices rise)
2. NAVs of debt funds increase
3. Long-duration funds benefit most because they hold bonds for longer

Medium-duration funds have delivered 8.7% returns in the past year, well above their typical 6.5-7% average. (Business Standard)

What This Means for You:

If you're parking money for 2-4 years, debt funds are unusually attractive right now. The combination of falling rates and capital gains has pushed returns higher than FD rates at most banks.

However, experts caution that much of this rally has already played out. Further rate cuts may be limited as RBI monitors inflation. The opportunity is still there, but don't expect 8%+ returns to continue indefinitely.

For debt allocation, consider:

• Dynamic bond funds: Adjust duration based on rate outlook
• Short to medium duration funds: Balance of stability and returns
• Gilt funds: If you want zero credit risk and can hold 3-5 years

The Hybrid Option: Why You Don't Have to Choose

What if you want both growth and stability but don't want to manage multiple funds?

Hybrid funds combine equity and debt in a single portfolio. SEBI categorizes them by allocation:

• Aggressive Hybrid Funds: 65-80% equity, 20-35% debt
• Balanced Hybrid Funds: 40-60% equity, 40-60% debt
• Conservative Hybrid Funds: 10-25% equity, 75-90% debt
• Dynamic Asset Allocation Funds: Vary allocation based on market conditions

Why Consider Hybrid Funds:

1. Automatic rebalancing: Fund manager adjusts as markets move
2. Tax efficiency: Aggressive hybrids (65%+ equity) get equity taxation, which is more favorable
3. Simplicity: One fund, one decision

Funds like HDFC Balanced Advantage and ICICI Prudential Balanced Advantage have delivered 14-18% over five years while limiting downside through dynamic allocation.

👉 Tip: For NRIs who don't want to actively manage allocations, a dynamic asset allocation fund is an excellent one-fund solution. The fund manager handles market timing.

Building Your Portfolio: A Practical Framework

Instead of asking "equity or debt," ask "how much in each?" Here's a framework based on age and goals.

Age-Based Starting Point:

A common guideline: Hold your age as percentage in debt. So:

• Age 30: 30% debt, 70% equity
• Age 45: 45% debt, 55% equity
• Age 55: 55% debt, 45% equity

This is a starting point, not a rigid rule. Adjust based on:

• Your actual risk tolerance (not theoretical)
• Income stability
• Other assets (property, gold, pension)
• Specific goal timelines

Goal-Based Allocation:

Rather than one mixed portfolio, separate your money by purpose:

• Emergency fund (immediate access): 100% liquid funds
• Car in 2 years: 90% short-term debt, 10% large cap
• Child's college in 8 years: 50% equity, 50% debt
• Retirement in 20 years: 75% equity, 25% debt

This mental accounting helps you match risk to timeline.

NRI-Specific Adjustments:

1. Currency exposure: Your income is foreign, investments are rupee. Factor in 3-4% annual depreciation when setting return expectations.

2. Repatriation timeline: If planning to return to India within 5-7 years, start shifting toward debt as your return date approaches.

3. GIFT City alternative: Both equity and debt funds available in GIFT City have zero capital gains tax for NRIs. For large portfolios, this changes the math entirely. Explore options like Tata India Dynamic Equity Fund or DSP Global Equity Fund through Belong.

Debt Funds vs Fixed Deposits: A Quick Comparison

Many NRIs default to FDs because they feel safest. Here's how debt funds compare:

Neither is universally better. FDs offer guaranteed returns and deposit insurance. Debt funds offer liquidity and potentially higher returns during falling rate cycles.

For most NRIs, a combination works:

• FDs for guaranteed returns and emergency backing
• Debt funds for potentially higher returns on medium-term money

Use Belong's NRI FD Comparison Tool to find the best rates across banks.

Common Mistakes NRIs Make

After years of conversations with NRIs, we've seen these mistakes repeatedly:

Keeping too much in savings accounts. Many NRIs have crores earning 3-4% in savings accounts. Even if you're risk-averse, liquid funds or GIFT City FDs offer better returns with similar safety.

Treating debt funds as guaranteed. Debt funds are NOT fixed deposits. They can lose money if interest rates spike suddenly or if underlying securities default. IL\&FS taught this lesson the hard way.

Chasing last year's equity returns. Many piled into small cap funds in early 2024 after seeing 45%+ returns. By late 2025, many were down 20-30%. Past performance doesn't predict future results.

Ignoring tax impact. A 12% equity return at 12.5% LTCG tax beats an 8% debt return at 30% slab rate. Always calculate post-tax returns before deciding.

100% in either category. Neither extreme is optimal. Even aggressive investors should hold 20-30% debt for stability and rebalancing opportunities. Even conservative investors need some equity to beat inflation over long periods.

Forgetting to rebalance. If markets rise and your equity allocation goes from 60% to 75%, you've become riskier than intended. Annual rebalancing maintains your target allocation.

The Bottom Line

The equity vs debt question doesn't have a universal answer. It depends on your goals, timeline, risk tolerance, and tax situation.

Here's the simplest framework:

• Money needed in under 3 years: Debt funds
• Money needed in 3-7 years: Mix, leaning toward debt
• Money needed after 7+ years: Primarily equity

Don't let analysis paralysis keep your money idle. Even a conservative 30% equity, 70% debt portfolio will significantly outperform a savings account over time.

The best allocation is one you can stick with through market cycles. An aggressive portfolio that you panic-sell during a crash will underperform a moderate portfolio that you hold steady.

If you're unsure about your specific situation, join our WhatsApp community where NRIs discuss these decisions daily. Get perspectives from others who've navigated similar choices.

Download the Belong app to explore GIFT City mutual funds with zero capital gains tax, compare NRI FD rates for the stable portion of your portfolio, and use our Compliance Compass to ensure you're following all necessary rules.

Your money shouldn't sit idle because you're confused. Start with what you understand, and build from there.

Sources:

• SEBI Mutual Fund Regulations
• Income Tax Department
• RBI Monetary Policy
• Groww Fund Performance Data
• INDmoney Fund Analysis
• Outlook Money 2025 Review
• Business Standard Debt Fund Returns
• ICICIdirect Rate Cut Analysis
• Gripinvest Tax Guide
• SBNRI NRI Taxation