Open a Trading Account

Register as Guest

Become a Partner

Please fill in your details

Debt vs Equity – Striking Balance between Debt and Equity

With a wide variety of investment vehicles available in the market, it can be challenging to select the right one to invest your hard-earned money. From company stocks, gold, real estate, bank FDs, debentures and bonds, to mutual funds and more, there are numerous avenues for investment. 

But even before you decide the right investment scheme, the first task is to determine if you are looking to invest in equity or invest in debt. Most investments are typically categorised between debt investments and equity investments. For instance, if you invest in an equity-based investment, it means you are directly or indirectly purchasing company stocks, and your returns will be related to how that companies perform. Say, you purchase 100 shares of a leading tech company; here, your returns will be based on the stock dividend which the tech company will pay and the rise or fall of the value of the company shares. Equity-based investments can be risky. And because of its high-risk factor, they typically offer a higher return rate in the long run.

On the other hand, when you invest in debt, you lend money to an individual, a company or a government establishment. With debt investments, your returns may not be directly related to how the borrower performs. For instance, if you purchase corporate bonds worth Rs. 10,000 and the company makes a profit, the returns will be the same as if the company had earned no profit at all. Debt-based investments are considered stable. And hence, they earn a low rate of return.

As an investor, you aim at profiting from your investments. However, to gain optimum profit, you need to analyse your risk profile. Once you know that you can choose between the two avenues once you know which option offers what benefits. Hence, it is essential to know the difference between debt and equity capital to get the best out of your investment.
Most people assume that all mutual funds are alike. On the contrary, there are various types of mutual funds, and primary among these are equity funds and debt funds. The chief difference between equity fund vs debt fund lies in the way the money is invested. When you invest in debt funds, you are investing in fixed income securities. On the other hand, equity funds primarily invest in equity shares and related securities. Equity funds and debt funds have sharply contrasting features that decide how the respective schemes invest and behave, determining their outcome.

To ensure you receive the best out of your investment, look into asset allocation. It can mitigate risks and help you enjoy the benefit of diversification, while at the same time offering you control over your assets and investments.

Asset allocation is a strategy an investor uses to structure their portfolio. Depending on your financial goals and risk tolerance, you can spread your investments between equity and debt. For instance, two friends may have the same financial goal but different asset allocations. While one may have a greater risk tolerance and thus be inclined towards assigning higher resources to equity capital, the other with a lower risk tolerance would look towards debt investments after evaluating the risk and capital needed towards the goal.

Wealth creation requires continual and planned investments to determine your financial goals. It is wise not to place all your eggs in one basket; financial experts advise allocating investments among various asset classes. As a critical strategy that can lower your risk and potentially enhance your returns, it is vital to understand debt-vs-equity and how it can work for you.

Striking a balance between equity and debt is a powerful concept that is mostly ignored. Regardless, it is easy to execute. Depending on the time frame of your investments and the amount of risk you can bear, you may want to maintain a specific portion of your financial investments in equities and the rest in debt and fixed income. This means that if the proportion of a particular asset class veers away from the desired ratio, you can move your investments from that asset class to another one to balance your portfolio.

Accurate asset allocation is critical to financial empowerment. Prudent asset allocation requires you to answer

• Where you should invest?
• How much do you need to invest?
• How can you invest?

When answering these questions, you identify asset classes and the amount you wish to hold in your investment portfolio. Here, one’s age becomes a critical factor in asset allocation as it changes according to the investor's life stages. For instance, a young investor may have a different financial goal as compared to a middle-aged investor. With regards to long-term financial goals, asset allocations must be adjusted periodically based on market conditions and the investor's age.

Typically, equity-based investments are pegged to provide higher yields than debt-based investment. If you are considering equity in the form of stock investment, it requires careful financial analysis to gauge the health of the company. Typically, it can prove beneficial to examine the balance sheet and cash flow statement of the company, and its profit and loss account. Analysing a company's financial health can be crucial in making smart equity investment decisions. Doing so can help you to know the company's performance and compare it with its contemporaries in the same industry.

On the other hand, while debt-based investments may offer lower returns, they are critical and serve useful purposes. For instance, they are often used to maintain one's money temporarily while waiting for a suitable equity-based investment.

The goal of allocating your assets is to get a return on your investment while managing and controlling the risk at the same time. That being said, there will always be market risk, and it can be impossible to eliminate risks altogether. However, with intelligent asset allocation, you can cut down investment risks, particularly, risks that come with just one specific investment. For example, if you invest entirely in the shares of one company, it could make you vulnerable to the risks that the particular investment could reduce in value. By diversifying your finances, you eliminate this risk while giving your investment the opportunity of making money with one asset class even if the other is declining.

Takeaway

It is always an excellent time to look into your asset allocation and understand if your investment portfolio is where you would like it to be. For example, if you observe that your current portfolio is heavily dependent on equities, you may want to consider adding debt investments. You can merely purchase more of debt investments such as debt mutual funds or exchange one asset for another until you have accomplished your expected allocation.






Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.