Introduction

Investing in mutual funds is an excellent way to grow your wealth over time. However, the vast array of investment options can be overwhelming, especially for beginners. Two fundamental types of investments in mutual funds are equity and debt. In this blog, we will explain what equity and debt investments are, how they work, and provide simple examples to help early investors understand these concepts and make informed decisions. So, let’s dive in!

Equity Investment

Equity investments, also known as stock investments, involve purchasing shares or ownership stakes in companies. When you invest in equity mutual funds, your money is pooled together with other investors and used to buy a diversified portfolio of stocks. The value of your investment fluctuates with the performance of the underlying stocks.

For instance, Let’s say you want to start a business in your neighborhood. In order to get things going, you need funding, but you don’t have enough to invest on your own. So, you approach your friends and family members and ask them to invest in your business. In return for their investment, you offer them shares in your company. Offering them shares in your company is your way of compensating them for their investment. An equity investment represents ownership in a business. When someone invests in your company and buys shares, they become part-owners. The total ownership of the company is divided into a certain number of shares, and each share represents a small portion. As the business grows and becomes profitable, each share’s value increases, allowing shareholders to benefit from their investment, and if the company performs well, the value of the shares can increase, resulting in capital gains for shareholders.

Key points to remember about equity investments:

– Higher potential returns but higher risks.

– Value fluctuates with the stock market.

– Diversification reduces risk.

– Suitable for long-term investment goals like retirement planning or wealth accumulation.

Debt Investment

Debt investments involve lending money to entities such as governments, corporations, or financial institutions in exchange for regular interest payments and the return of the principal amount at maturity. When you invest in debt mutual funds, your money is invested in fixed-income securities like government bonds, corporate bonds, treasury bills, or certificates of deposit.

Let’s consider an example to illustrate debt investments. Your business has been running successfully for a few years, and you want to expand operations by opening up a new branch. However, you need a substantial amount of money to finance this expansion. In this case, you approach a bank and apply for a business loan.

When you borrow money from a bank or any other lender, it is known as debt. The lender provides you with the funds you need, and in return, you agree to repay the loan amount along with interest over a specified period. As equity profits of a company are being shared by the owner’s i.e. shareholders. Debt does not involve sharing ownership of the company. Instead, it creates a legal obligation for you to repay the borrowed amount and if the company goes bankrupt and is being liquidated then the debt holder or bond holder investor gets the first share of their money repaid.

Key points to remember about debt investments:

– Lower potential returns but lower risks.

– Regular interest income and relatively stable value.

– Suitable for short-term goals or conservative investors seeking income stability.

– Credit quality and interest rate risks should be considered.