Investments are often made on tricky roads; a wrong choice would often lead to heart aches.
This makes clear understanding of the investment options, benefits, and its outcome a must.
Let us take the case of mutual funds, There is enough awareness about mutual funds these days, but have you realised that they are invested in equity or debentures?
Here let us talk in brief about debenture and how they are different from equity.
As an investor, one must have a clear perspective about equity and debentures and the pros and cons of investing in each of these.
Equity and Debentures
Be it government, company or a corporate, two kinds of fund sourcing is carried out.
The first kind is equity where the transferring of ownership of the company to the investors and issuing shares occur. The outcome is investor will be on loss if the company is on loss whereas he makes dividend when the company is on profit.
The second kind is issuing debentures as debt at a certain rate known as coupon. For example, if an investor buys debenture/debt/or bond at 10 percent interest rate from a company, the company is liable to pay that 10 percent interest every year irrespective of whether it is at loss or gain.
Now what differentiates the equity and debentures is that in equity- the ownership of the company rests on investors while in debentures- debt is issued at a certain rate and the company is liable to pay the debt amount and the interest.
How do we know whether to invest in a specific debenture or not?
Every debenture is given a rating by the rating agency. The rating is given considering the repaying capacity and the goodwill of the company. So, make sure to invest in those debentures with a good rating.
Investing in equity and debentures has its risks involved. If the company is on profit, equity holders make dividend and at the same time bears loss in case of the reversal.
The margin of profit and loss is unlimited in case of equity.
In debentures, company is liable to pay a certain amount as interest to the investors irrespective of its financial condition. For those who seek regular income, debentures serve better.
Do and don’ts
- Make sure to invest in debentures with good rating and those that are trustworthy.
- Remember that if the company defaults the debenture, the investor will be at loss. Going for secure bonds of government organisations bring better result.
- Investing in good mutual funds ensures average or minimum return as mutual funds are diversified holdings.
Be it equity or debentures, investments involve risk. But understanding the merits and demerits of both helps the investors to take a decision depending upon their financial situation.