There’s a great deal of fantastic financial advice from seasoned experts out there in the world, but the reason so many of us aren’t able to act on it is that experts generally tend to use technical terms or employ finance jargon. So when a finance expert says something like ‘you need to diversify your equity holdings’, the first question that pops into your head is what is equity, even?
So, What Is Equity?
Equity, in very simple and basic terms, refers to absolute ownership. Your personal equity refers to the assets that you own, reduced by the loans that you may have taken on them. So if you own a house and a car, your personal equity is the total value of your house and car, minus whatever is left of your housing loan and your car loan.
Investing in Equities
Just like your own personal equity, every company has equity as well. It is the value of all their assets, reduced by debt. This is also referred to as the Company’s ‘Net Worth’. So when you buy equity or invest in equity, you’re essentially buying into the ownership of the company. So when you buy a company’s share, you’re literally buying a share. FINANCE IS EASY, FRENZ. Equity Mutual Funds are those that invest exclusively in shares of companies – to know more about Mutual Funds, read my post on the basics of Mutual Funds, here.
Why Are Equities Risky?
There is a lot of chatter about how equities are risky and that you should be wary of them. The reason equities are considered risky is because they’re directly affected by how well or how badly a company performs. It’s entirely possible that a company which is doing amazingly well one day can come crashing down to the ground on the next day – this could be because the company had faced a massive setback (eg: CEO is charged of fraud/embezzling) or even because the industry in which it belongs faces a massive setback (eg: all of the middle-east petrol reserves have been captured by terrorists). So if you choose to invest in equities, it means you are choosing to run with that risk.
Equity Mutual Funds are also risky investments, but, they are diversified. Let’s say you have Rs. 100/-. The riskiest thing for you to do would be to put that Rs. 100/- directly into the share market and buy the shares of a company. If the company does well, your Rs. 100/- will skyrocket to Rs. 500/- in a few years. If the company runs into some bad luck, however, it’s entirely possible that the Rs. 100/- you invested becomes Rs. 15/-. Equity Mutual Funds will take the same Rs. 100/- and split that up between the shares of 10 to 15 different companies. So, even if one company does badly, the effect on the total value of your investment is diluted.
Should I Invest in Equities?
Investing in equities is easy. Success with equities, on the other hand, requires luck, skill, knowledge, and experience. Investing in equities by yourself isn’t recommended unless you’re fully aware of what you’re doing and/or have a lot of cash to burn. The rewards are plenty, yes, but remember the risk that you’re putting your money through. A successful portfolio is a well balanced portfolio.
So what makes a well-balanced portfolio? We’ll discuss that in the next post!