Everything you Need to Know about Equity Investment

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Equity Investment

The main objective of making investment is to earn profitable returns on it and accumulate wealth over a long term period. Investment returns can either be fixed or market-linked. On today’s day and age there are wide range of investment products available in the market. For instance, market linked investments like mutual fund, stocks, etc. or fixed return investment like bank FDs, RDs, Post office deposit, etc. Further in this article we will elaborately discuss about the equity investment.

Equity and Non-Equity Investments

As the name suggests, fixed return investment instruments, provides investors a fixed (predetermined) rate of return during tenure of the investment. Since fixed return instruments offers low market risk it is   considered to be secure and safe option of investment for individuals who have a low risk appetite.

On contrary to this, the market-linked investment instrument such as equity investments offers higher returns on investment in a shorter period of time. However, the returns are subjected to the market risk and entirely depends on the performance of the fund. Market-linked investment can further be classified into two main categories i.e. equity and non-equity investments. In equity investment, the money is majorly invested in equity derivatives different companies.

In non-equity, the investment is majorly made in bonds like corporate or government and also in other money market instruments like certificate of deposits, treasury bills, repurchase agreements, commercial papers, , etc.

Since the ROI of these funds entirely depends on the market performance, both equity and non-equity investment options has its own set of risks and rewards. There are different types of fund options offered by equity investments let’s take a look at the types of fund offered under equity investment.

Types of Equity Investments

Equity Linked Savings Scheme (ELSS)

An equity linked saving scheme is also known as tax saving scheme. ELSS fund provides the dual benefit of tax exemption and equity investment. These funds have diversified portfolio, wherein the investors can choose to invest in small, mid-cap and large-cap companies as per their own choice and suitability. The investment returns on equity linked saving scheme are eligible for tax exemption U/S 80C of IT Act 1961. This fund option is best suitable for individuals who wants to gain high return on investment over a long-term period along with the benefit of tax saving.

Sector Equity Fund

Sector fund are a type of equity fund in which the investment is primarily made in shares of companies operating in single sector like financial services, technology and healthcare. As in sector fund the investments are made in a fixed sectors, the return on investments are not very high as compared to the investment risk. This fund is best suitable for individuals who have a high risk appetite and wants to invest in a single sector.

Equity Diversified Fund

In diversified equity fund, the investments are made in diversified portfolio of small cap, mid-cap and large-cap companies, irrespective of the sector and size. In order to maximize the profit and to provide maximum return on investment, the investment is diversified across stock market. Diversified equity fund are offered by unit linked insurance plan, mutual fund, etc. As in diversified equity fund, the investment is made in different sectors and industries, it can participate in the growth of different funds across the economy. According to one’s own choice and suitability, the investors can choose to invest in companies from technology, automobiles, pharmaceuticals, oil and gas, financial services and banking, engineering, power/ utilities, etc.

Diversified equity funds aims to provide an opportunity to the investors to create wealth and achieve their long-term financial goals by making investment  across various companies.

Global Fund

Global equity funds are extremely diverse category of fund. Under this fund option the investment is majorly made in companies located globally, including the investor’s own country. For example, a gold fund invests in gold mining stocks across the world. A global equity fund tries to find out the best investment from the global market of equity securities and make investment in it in order to provide lucrative returns on investment. As it provides the investors a diversified portfolio of global investment, the potential of investment returns also increases and so does the market risk.

Global fund can be allocated to different asset classes or can be focused on a single asset class. This fund option is best suitable for individuals who have a high risk appetite and wants to gain higher return on investment.

Hybrid Fund

Hybrid funds are also known as balanced fund in which the amount is invested in both equity and debt securities. Under this scheme 65% of the amount is invested in equity and equity related securities and the rest 35% of amount is invested in debt fund. Hybrid funds are less volatile as compared to the pure equity fund as the debt fund offers stability in times of volatility. This fund is a great option of investment for investors who are investing for the first time and are new to the market. So, the investors who have a low risk appetite and want to a steady return on investment can consider investing in this fund.                                                            

Key Risks Associated with Equity Investment

All type of investment which offers market-linked returns is connected with a part of risk. Risk involved in Investment basically specifies the possibility of financial loss because of uncertainties involved due to many different factors. Here we have discussed some of the key risks related to equity investment.

Market Risk

Market risk includes the possibility of incurring losses in investment due to market factors. In case, the financial market is not performing well due to reasons such as economic slowdown or any other such factors it will impact the overall markets negatively. Market risk is also called as systemic risk as it is largely dependent on macro factors. Thus, market risks are limited to any specific industry or company. However, based on the type of market risk different investment sectors may get affected in different percentage. Since market risks cannot be controlled and affects all companies, it can be managed only to a particular extent with  the diversification of portfolio.

However market risk also offers an opportunity to the equity investors to choose quality stocks at reasonable price that can potentially produce high returns in the long term. This is the reason why the investors who try to time markets have a tendency to make lump sum investments during the period of  market slowdown caused by market risk. However, during the time of market slowdown, existing investors have limited options of downside protection.

Performance Risk

In equity mutual funds investment are made in individual stocks and there is no guarantee on the performance of the stocks as per expectation. This is the known as the performance risk and from time to time it affects both the entire sectors as well as individual stocks. Performance risk generally affects thematic funds or sectoral to the maximum degree as they aims to invest in portfolios that emphasis on the industries related to a predetermined theme like  healthcare, consumption, mining, energy, etc.) or specific industry.

The key strategy that MF investors applies to minimize performance risk is diversification majorly across themes, industries and market capitalizations.

For instance, recently, the pharma sector had faced headwinds due to both global as well as domestic factors which has affected pharma funds negatively, creating performance risk pressure on such funds.

Liquidity Risk

Any fund offers the option of liquidity wherein the investors can sell the fund in a sufficient quantities and at a fair price as per required by the investors. The investors may face the problem of liquidity risk on equity investments which offers the facility of liquidity. In liquidity risk the investors are forced to sell the funds at a lower price as compared to the actual market price of the fund, particularly in case of an emergency. Usually, stock funds are more likely to liquidity risk which are traded in low volumes on stock exchanges.  

In order to minimize the liquidity risk of equity investment, there are many mutual funds schemes which offers the option of investing a share of their assets in different money market and debt instruments that offers a higher liquidity as compared to equity investment. Therefore, an equity mutual fund will have to maintain a higher equities allocation in its portfolio on comparison to the debt/money market allocation.

Social/Political/Legislative Risk

Any type of social, legislative and political changes can result to changes in the fund performance. For example, if a country encourages its homegrown company by increasing entry barriers to foreign businesses, then the local industries are guaranteed to perform well till the time the entry barriers are removed.

Subsequent the removal of these entry barriers will result in removal of protection which will result in the downfall of fund performance. This type of risk occurs in case of many businesses and the only strategy currently applied with respect to manage this type of risk comprises diversification across several industries as well as across national borders.

Currency/Exchange Rate Risk

Currency risk is also known as exchange rate risk which occurs due to changes in exchange rates between currencies.  Those investors are likely to face currency risks who have exposure of investment to overseas equity markets. Apart from that, the type of businesses which make a maximum part of their earnings from global operations also prone to face an exchange rate risk. For example, businesses belonging to IT, pharma or other export-oriented sectors are prone to face currency rate risk due to their high exposure to foreign markets.

One common strategy to alleviate this risk is by maintaining a cash reserve or keeping hold of highly liquid assets whose allocation can be decreased or increased in order to balance the changes in exchange rate or other risk related to currency faced by equity mutual fund scheme investors. Such risk mitigation practices are also known as hedging techniques.

Who Should Make Equity Investments

Equity investment is lucrative investment option for investors which have the willingness and ability to take a risk. Market-linked Investment tools are not very profitable for the risk-averse individuals. Before investing in equity investment it is very important to have a proper understanding of the market as the success of the equity funds largely depends on the knowledge and skills of the investor’s. However, the investors who are restricted with the limitation of time and have adequate knowledge can earn profitable returns on investment at medium risk by investing in equity mutual funds.

The next important factor the investors should consider is the capability to stay invested for the long term. Investors are required to understand that equity investments are volatile in nature and can lead to considerable swings in valuation in the short term. The longer one stay invested in the market, the higher returns they are tend to reap in a long-term, as in the longer tenure, equity markets have always moved upwards.

Investors who want lucrative returns at moderate rate should invest in equity and securities related equity investment. If you are new to the market then you can seek advice of market experts who will not only help you to put your investment in the right equity fund but will also help to create a strong portfolio so that you can gain maximum return on investment.