A dilemma every investor faces at the beginning of investment journey is whether to invest fully into Equity or fully into Debt instruments or have a balanced investment in both the instruments. Some people advice based on age i.e if you are young, invest majorly into equity and as the age grows invest more into debt instruments. Some people advice on risk i.e if you are risk-taker then invest into Equity and if you are a risk-averse then invest into Debt instruments. Some people advice only Equity and some people advice only Debt instruments. No one is wrong here. But one thing is for sure that you will lose money if you blindly follow someone's advice ("Tips"). Therefore it is very important to understand the equity and debt instruments and take decision based on your preferences and be bold to follow "Suno Sabki Karo Manki". One will make mistakes in this but will overcome those with a period of time.
Let's understand how exactly the equity and debt system works. Companies/Corporates/BusinessMen require money to run the business. It might be for various reasons like scaling or growing the business, during liquidity crisis for company, for current operations, etc. This money can be raised in two broad ways i.e by selling some part of the company (Equity/Sharing) or by asking for money (Debt/Lending). That means when you invest in Equity, you are the owner (shareholder) of the company and when you invest in Debt, someone is borrowing money from you and will pay you back with interest (byaj). Therefore, if you invest in Equity and business doubles, then your money value doubles and if the business bankrupts, your money vanishes as well. Despite knowing this fact, many people invests in bad business hoping their value will come back to normal. At the same time, if you invest in Debt the perk you get is the interest paid by business for lending them money. Hence, it is a safer bet as it is compulsory for businesses to pay the debt. Does this mean debt is completely safe ? No. Not everyone is a Lannister !! (ref : Game of Thrones) If business fail to pay debt and they don't have enough capital to get liquidity, your money vanishes as well. Hence, credibility of business matters and this is identified by credit rating agencies. CRISIL, ICRI, CARE are Indian and Moody's, S&P's, Fitch are International rating agencies which give ratings like the teachers give grades for exam papers. Infact these credit rating agencies have also lost their trust, but that we'll cover in another article.
After reading above paragraph, you might think this is very basic and I know this !! Yet majority of investors prioritize the past returns of investment (addictive caffeine) and fail to prioritize the business of the company they are investing into.
Investing in Equity :- Stock Market shares, Equity Mutual Funds, ETFs are ways for common public (retail investors) to buy equity in a company. This is post (Initial Public Offering) IPO of a company. Few important things to look while investing is the past/current/future business value of the company, corporate governance i.e who is running the company and how? and financial condition of the company (balance sheet / income statement / cash flow statement). Even if you are investing into mutual funds, it is wise to have a look at least at the Top 10 holding companies of the fund. Other type of equity investing is Private Equity i.e where Investing firms invests into business. These firms mostly invests into businesses pre-IPO.
Investing in Debt :- Bonds, Debentures, Commercial Papers, Certificates of Deposit, Fixed Deposits, Debt Mutual Funds are major debt instruments. Few important things to look while investing in debt instrument is the credit rating. The credit rating from high to low are AAA, AA(+/-), A(+/-), BBB, BB(+/-), B(+/-), CCC, CC, C, D. Ratings from BB+ are considered junk. They will offer high returns but the probability is very high that instrument will not be able to get the money back or default. Other thing to look is the maturity period of the debt instrument. Your money will be locked-in till maturity and you might have to pay penalty for withdrawing your funds before maturity. Liquid funds are exception. If you are investing into corporate debts, it is wise to look at the possibility of the default in the business. As rating agencies can be over-optimistic, it is better to be sure from your side as well. People trusted the ratings agencies blindly and have lost their corpus due to Lehman Brothers collapse (2008) and IL&FS crisis India (2018).
Risk-Reward in Equity and Debt
Equity investments are risky as the failure of business leads to drop in value of your investment but at the same time if the business grows, rewards can multiply your money. Though this sounds attractive, the statistics is that 95% of people lose money in stock market. If you are profitable, you are in top 5% investors. Great investors like Warren Buffett, Peter Lynch, Rakesh Jhunjhunwala, RadhaKishan Damani have proved the world the power of equity investing. The worst-case scenario is that you will lose all your money in stock market. Today, equity mutual fund has become a attractive investment in India as it is handled by professionals and the investments are diversified (not putting all eggs in one basket). Usually goal in equity investments is to grow capital over a long period of time.
Debt investments are less-risky as compared to equity investments. As the risk is less, rewards are also limited. The returns are predictable and risk of losing the principal amount is less. Debt instruments are attractive, if the investor needs a regular income and if the investors needs this money in near short-term. Many equity investors, prefer debt investment for diversification of their portfolio. And many professional stock market traders prefers to invest in debt investment to get a stable returns. They then pledge(girvi rakhna) this investment for their trading activities. One can expect a modest returns of 7-10% from debt investments. One has to be aware that more returns in debt investments may be a risky borrowing for mere 1-2% extra returns. You should invest in Equity if you are so willing to take risks.
Risk management and understanding risk is very critical to preserve your money. Warren Buffett wisely said Never Lose Money. Hence, one can create his/her own strategy for investing with Equity & Debt. It is better to make your own rules rather than following someone else's blindly.
Thank You.
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