A Beginner’s Guide to Equity Investment
Equity is the degree of ownership that an individual holds in a company or an organization. If you hold 20 percent equity in a company, it means you will become a 20 percent owner in that company. In the future, if this company earns profit, your capital will rise, and if it experiences losses, you will not have any returns. The most important part of equity investment is that it gives you voting rights in the company, which means you will have a say in the day-to-day affairs of the company. Let’s elaborate on what is an equity investment in detail.
What is an Equity Investment?
The concept of equity investment refers to the process whereby investors buy shares straight from the companies or other investors in the hope of reselling them for cash or earning a profit through a dividend. This dividend is a system in which a company shares its surplus profit among its shareholders.
Types of Equity Investments
Multiple investment avenues are available under equity investment, each with their individual risks and rewards.
When you hold a small part of ownership in a company, it is called shares, and you, as an investor, become a shareholder. In such a case, you get to share the company’s profits with the other investors according to your proportion. However, the risk factor varies for different stocks; the greater the risk, the higher the profits you earn from the shares.
Equity Mutual Funds
Equity mutual funds, one of the most popular types of equity investments, imply investing in equity shares or partnership shares of different companies. It offers the option of investing regularly in small amounts through systematic investment planning (SIP) to generate profits. Those who are not interested in investing in individual shares should opt for equity mutual funds. Equity mutual funds also come in the following categories:
- Large-cap funds: These schemes invest in companies with large capitalization and offer long-term profits along with moderate risks. In comparison with mid-cap and small-cap funds, these funds are less volatile.
- Mid-cap funds: These schemes invest in companies with mid-market capitalization and offer long-term investment returns along with a comparatively higher risk factor.
- Small-cap funds: These schemes invest in companies with small market capitalization and offer high risk as well as high returns.
- Multi-cap mutual funds: These schemes invest in a mix of large, medium, and small market capitalization companies which allows better movement of funds between the stocks.
Arbitrage Funds are hybrid mutual fund schemes that take advantage of price differences between underlying assets in different capital market segments in order to generate arbitrage profits. Funds like these can also invest in debt and money markets.
Alternative Investment Funds
Funds established or incorporated in India that are privately pooled investment vehicles, whether they are Indian or foreign, are known as Alternative Investment Funds, or AIFs. They collect funds from sophisticated investors and invest them in accordance with defined investment policies for the benefit of their investors.
Under the provisions of the SEBI Mutual Funds Regulations 1996 and SEBI Collective Investment Schemes Regulations 1999, AIF does not include funds covered by those Regulations or any other regulation made by the Board to regulate fund management activities. The AIF Regulations also provide certain exemptions from registration for trusts established for the benefit of ‘relatives’ under the Companies Act, 1956, employee welfare trusts and gratuity trusts established for the benefit of employees, holding companies within the meaning of Section 4 of the Companies Act, 1956, etc.
Benefits of Equity Investment
There is a growing trend of investing in equity in India. This is because of its benefits in terms of return and other aspects.
- Ownership rights
When you buy shares, it enables you to exercise control in the company, gives you voting rights, and also lets you enjoy a portion of the income earned by the same.
- Higher returns
It gives you higher returns compared to other traditional FDs in a shorter duration. Moreover, with the right selection of stocks and a trading strategy, you can earn good returns in the future.
- Additional income through dividends
Investing in equities not only gives you the option of earning through capital appreciation but also from dividends, providing an extra income for the investor.
- Limited responsibilities
You will always find the association of risk with running a full-fledged company, but when you buy a share, you have limited responsibilities.
- Safe practice
Since SEBI protects the stock market, the investors’ rights are protected and safe while trading, which cuts down the risk of fraudulent behavior of companies as well as individuals.
- Flexibility in trading
The stock market allows you to trade in small amounts and also lets you purchase, sell, or hold a share for whatever time.
- Simplifies buying and selling
Investing in equity is a simple process; buying and selling stocks can be done online or through a broker or a financial adviser.
Also Read: What Is GPF- General Provident Fund
Risks with equity investment
There is a considerable amount of uncertainty involved in equity investment. Equity follows the simple market principle; if the risk is higher, the return will also be higher.
- The most significant risk associated with equity investment is the market risk caused by the volatile nature of the stock market, which fluctuates very quickly and unpredictably. The price of a single stock could rise and fluctuate multiple times in a day, impacting the returns.
- Financial risk is the second significant risk of investing in equity shares. Any internal disturbance in the financial matter of a company will directly influence the share prices of the investor.
- The liquidity risk is always there with equity investment. This means those securities which are not listed and featured in the stock market are considered illiquid, which means they cannot be easily converted into cash. They carry substantial liquidity risks. However, those securities that are listed on the stock market still carry liquidity risk. Sometimes the investor companies cannot fulfill their short-term obligations within the specified time. In such situations, the investor might be compelled to sell their shares at a low rate in fear of total loss.
- Exchange rate risk is another type of risk associated with equity investment. The revenue of those companies involved in software and export-import is, to a large extent, dependent on foreign countries. This is influenced by the current exchange rate in the economy. If there is a fluctuation in the currency, it will impact the profit and shares of the companies.
- The stock market is also impacted by the social and political issues of the country. The state of the economy in a country includes the interest rate, inflation rate, and balance of payment. Any disturbance in any of these sectors will directly impact the financial scenario, affecting the companies’ financial performance, including the equity shares. The market may not perform as per the expectations of the investors. Performance risk is always associated with an investment in direct equity, which might affect a single stock or the entire stock.
According to experts, equity is an asset that gives you maximum profits if you invest diligently by minimizing risks and earning your targeted return. As you now comprehend well the meaning of equity investment, you will be exposed to proper financial planning with a better understanding of the market. And thus, you make your way to earning stable returns.
What is direct equity investment? How does it work?
It is an investment whereby an individual investor buys shares or stocks from a company directly without taking the help of any manager to make profits from them. It involves considerable risks and is hence recommended for experienced investors.
What are the types of equity investments?
Stocks and shares, equity mutual funds, real estate funds, and arbitrage funds are some types of equity investments. All these types of equity investments are subjected to some amount of risk.
Who should invest in direct equity?
Individuals who aim for long-term growth should invest in direct equity. Direct equity is when the investor receives his share of a company directly from the stock market. Those with extensive knowledge of the stock market and equities are ideal for this direct equity investment. Here the investor enjoys the freedom to make his portfolio.
How does an arbitrage fund work?
The purpose of arbitrage funds is to generate profits by trading simultaneously in the futures and cash markets in order to benefit from price differentials in the derivatives and cash (or spot) markets.