Things You Must Know About Equity Investing

Investing is all about accumulating wealth over time. There are different types of investments. The return on investment varies across products. Investment returns can be market-linked or fixed.

Equity investment means money is invested in a company by purchasing the shares of that company. Equity investing is often considered as gambling because of the nature of operations. Return on investment is high, but involves a risk factor. Returns are dependent on market dynamics. It is an ideal investment to earn higher returns over a short period of time.

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Things You Must Know About Equity Investing

Before investing in equity, it is beneficial to know about this investment:

Types of Equity Investments:

a. Equity Linked Savings Scheme (ELSS)

This investment offers dual benefits: This is high returns and tax benefits. It has a diversified portfolio across sectors. Investors can opt to invest in small, mid-cap or large cap companies as per their preferences. It offers high returns over a long period of time.

See Also: What is an Equity Investments? Why Should You Invest in It?

b. Sector Equity Fund

This investment consists of shares of companies in a single sector like the finance sector, healthcare and so on. Investment risk is high, but returns are comparatively lower due to a lack of diversification.

c. Equity Diversified Fund

In this fund, investments are made in small-cap, mid-cap, and large-cap companies; irrespective of size and sector. This ensures the portfolio is well diversified. This results in maximum returns on investment. Sectors and companies can be chosen by the investor himself.

d. Global Fund

Investments made in companies located globally are called global funds. Along with providing a diversified worldwide portfolio, return on investment is also high. Market risk is also high.

See Also: How Equity Investors Make Money in a Slowdown?

e. Hybrid Funds

Hybrid funds invest in equity and debt securities. About 65% of funds are invested in equity and the remaining 35% in debts. Risk factor is less in hybrid funds as debt securities provide stable returns.

Risks Involved in Equity Investments

An important feature of market linked investments is risk. Risks of various types are linked with equity investments as well. These are:

a. Market Risk

When the financial market is not performing well, equity investments also crash. Market risk can be controlled to a limit by diversification. Sometimes, only a particular sector or industry is affected. But its impact is witnessed by other related sectors as well. During a market slowdown, investors can invest a lump sum in quality stocks at a reasonable price, which have the potential to produce high returns.

See Also: 7 Reasons to Invest in Equity Mutual Funds

b. Performance Risk

There is no guarantee on the performance of these investments. Example: Pharma stocks crashed when the pharmaceutical sector faced a crisis recently (FDAsends warning letters to Indian Pharma Firms).

c. Liquidity Risk

In equity investments, investors are forced to sell shares at prices lower than their market prices, when there is a financial emergency. To avoid this, equity fund investors must invest a portion of their assets in different money market and debt instruments that offer high liquidity.

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d. Currency Rate Risk

Equity investments in global funds face a currency or exchange risk. When earnings are converted to Indian currency, exchange rate risk might result in profit or loss depending on prevailing rates.

e. Social/Political/Legislative Risk

Any social, political and legislative changes may impact the performance of equity funds. For example: a new rule in favor of the healthcare sector will result in better performance of healthcare companies. This will fetch the investors high returns. At the same time, a rule against the healthcare sector will have a negative impact on the performance of the fund.

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Important Things to Know Before Investing in Equity Funds

1. Uncertainty is the underlying feature of equity investments. Equity investing means investing in the future of a business. There is no defined rule to decide which business would succeed or fail. This means, you don’t know beforehand how your investment will perform in the future. This makes it scary, thrilling and risky at the same time.
2. Stories of great investors might give you the misconception that stock markets will pay you millions in the future if you buy cheap stocks now. But this is not true. Only an investor will know the real risk involved. Key point to remember is that nobody pays you for doing nothing.
3. Picking stocks is not easy. Many factors influence the life of a stock. Some factors play a significant role while others do not. Deciding which factor to focus on is not an easy game. Experienced investors will have the knowledge to judge which stocks to look for based on the signs. However this cannot be 100% true.
4. Decision to buy a particular stock is tough. There are several 100 stocks in the national and international market, and nobody can predict which one out of them will turn out to be a multibagger. In the formal investment set up, fund managers write down the reason for choosing a stock. This helps compare the real success of a stock. Different investors have different motives. For a short time investor, time plays a major role whereas for a value investor it is the margin of safety that matters. All this contributes to the decision of buying a stock.
5. Analysis of a stock requires expertise and knowledge in the stock market or related educational course. Ordinary investors lack this. Mutual funds hire brokers who in turn hire and pay qualified employees for databases to track stocks, sell reports and carry out research. An ordinary investor must utilize publicly available information and do extensive homework.
6. Equity stocks involve risk. To outlive this risk factor, diversify your portfolio. Build a portfolio and keep track of what it holds and how much.
7. Success in equity depends not only on your selection of stocks, but also on your assumptions. If you recognize a stock in which you invested is not performing up to your expectations, sell the stock and do no erode your capital. Do not hang on to a stock with false expectations.

Conclusion: Equity is an effective method of investing. If you are of the opinion that individual investing is risky, invest in equity mutual funds. They are less risky. It gives high returns over a short period of time. However, keep the risk factors involved in mind.

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