Most investments can be categorized as either debt or equity investments.
What are equity investments?
In an equity investment, you buy a portion of an asset or a company and your profit depends on the performance of that asset or company. Lets say you buy a garment boutique your profit will be based upon the performance of that boutique. If the boutique performs well you will get the benefits but if it doesn’t you will bear the losses.
What are debt investments?
In a debt investment, you loan money to a person, a business, or a government institution. With a debt investment, your profit is not directly related to the performance of the borrower. Lets say you lend Rs. 1000 to Reliance and Reliance makes a record profit that profit will not affect your investment at all. This is because irrespective of profits or losses, Reliance is obligated to pay your Rs. 1000 with interest on maturity unless of course Reliance goes bankrupt!
Equity v/s Debt Investments: Which one to pick?
Investing in equity is generally with the hope of earning greater returns. Debt investments typically offer lower returns.
2. Risk levels
Equity instruments irrespective of type, can be volatile and experience significant highs and lows in values. Debt instruments on they other hand are much safer. Mostly the debt instruments issued by governments are safer than those issued by companies.
3. Nature of Returns:
Returns from Equity Market are in the form of dividends, whereas returns from Debt Market are in the form of interest.
4. Tax Liability
Equity investments held for 12 months or less are considered “short-term” are taxed at a flat rate of 15%. Equity investments held longer for 12 months are considered “long-term” and are exempt from tax.
For short- term debt investments, the capital gains is added to the investor’s income and then taxed according to the slab they fall under. Whereas long term capital gains tax is applicable on debt investments held for more than 36 months at a rate of 20%.
What are some of the debt based instruments in India:
- Savings Accounts
- Bonds: These represent a loan given to a company or government in exchange of regular interest payments and repayment of loan amount on maturity.
- Debentures: These are similar to bonds but they are not as secure as bonds. Debentures depend on the credit worthiness of the company unlike bonds.
- Debt Based Mutual Funds: These are mutual funds that invest purely in debt markets.
What are some of the equity based instruments in India:
- Shares or Stocks
- Equity Based Mutual Funds: These are mutual funds that invest purely in the stock markets and equity markets.
Historically equity has shown annualized returns been 16%-20% compared to debt instruments which give annualized returns between 8-10%. But debt instruments are safer. So when one invests she should remember than no one single investment option debt or equity would be enough to meet her financial goals. She should have a mix of both in her investment portfolio. So before investing consult an advisor or an expert and decide which ones best for you.
If you still have any questions relating to debt or equity investments comment below and we will address them!