Have you ever wondered which category your investment falls in? Well, if you haven’t thought about it, then let us tell you that most of the investments fall under broad categories. Two of the popular asset classes are debt and equity.
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. Investing in the stock market is equity investment. For example, if you buy a stock of a company, the dividends that you will earn from the company will depend on their profits and earnings. Also, companies can reinvest their profits instead of distributing profits.
Investing in equity mutual funds is also a type of equity investments as it invests in a basket of different stocks.
You need to remember that when you are an equity investor, you are a shareholder or a partner of the company/
What are debt investments?
While in equity investments, there is a partnership relationship, in debt investments, the relationship is that of lender and debtor. With a debt investment, your profit is not directly related to the performance of the borrower.
The borrower is entitled to pay you back the principal and along with the interest. The debt investor comes before equity investors.
Some of the popular debt instruments are fixed deposits, debt mutual funds, recurring deposits, public provident fund etc.
Equity v/s Debt Investments: Which one to pick?
Historically, it has been seen that in the long run, equity investments have the potential to generate higher returns and build wealth. 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. On the other hand, debt instruments are much safer and many debt instruments provide a fixed interest rate.
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 gains less than Rs.1 lakh are exempt from tax.
For short- term debt mutual funds, the capital gains are added to the investor’s income and then taxed according to the slab they fall under. Whereas long term capital gains tax is applicable to debt mutual funds held for more than 36 months at a rate of 20% with indexation benefits. Indexation is nothing but considering the inflation rate while calculating the capital gains. For example, if the inflation in the year has been 5% and the returns given the debt mutual funds were 8%, then the taxation will be applicable on the 3% returns above the inflation.
What are some of the debt-based instruments in India:
- Savings Accounts
- Government Bonds and Debentures: These represent a loan given to a company or government in exchange for regular interest payments and repayment of the loan amount on maturity.
- Debt Based Mutual Funds: These are mutual funds that invest a major part of their portfolio 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 you are investing, you should remember that the asset or the proportion of one asset in your portfolio depends on your goals. Ideally, you 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!