Difference Between Debt and Equity
Are you planning to invest in Securities? Then, you are likely to come across “debt” and “equity” a lot. These two words define two broader markets in the realm of investments. So, in this article, we aim to help you understand the difference between debt and equity, and how you can use it in your favour to earn the most profits.
Let us begin with the basics of debt vs equity markets.
What is the Debt Market?
Also known as the bond market, since bonds are the most common debt investments, the debt market is where a company or a government organisation seeks funding in the form of loans. The lenders, in this case, are called the bond or debt holders. In return for the money granted, the bond issuer or the company has to offer interest along with the principal amount.
The debt assets are traded on the debt market, between direct investors or brokerage houses and organisations.
What is the Equity Market?
Also known as the stock market, this is the market where the shares of a company are traded, wherein a share denotes exactly what it means, a portion in the company’s ownership and financials. Now, depending upon the number of shares you own in that company in the ratio of the total number out there, you will receive a part in the company’s profits. This is paid out in the form of dividends, bonuses, etc. However, since equity funds depend on the actuals of the company whose shares you own, they are far more volatile than debt funds. You do not get a guarantee of returns with equity securities.
Interesting difference between debt and equity
Equities are directly regulated by SEBI (Securities and Exchange Board of India).
Since bonds and debt securities are essentially loans, they fall under the regulatory effect of RBI (Reserved Bank of India) as well as SEBI.
Now that we know the basic difference between debt and equity, let us further dive into a full comparison between the two. Difference between equity and debt market:
Equities fluctuate every second the stock market is up and running. What this means is that with equities, you can lose money rather than making it! There are fluctuations in some forms of debt instruments as well, however, in the case of the fixed-rate bonds, you get a pre-decided fixed interest as well as your mandatory principal/ face value of the bond upon purchase.
This makes debt instruments a far less turbulent choice.
Because equities fluctuate so much, there can be an upside too! When you sell the stock off during the high tide, you rake in multiple-folds of what you had invested.
However, with debt instruments, there is a limited and pre-decided scope. It is generally found that debt instruments are more stable and less riskier, however, their returns are shorter too.
A bond gets you a token confirming your lending into the company, however, it doesn’t make you an owner or a stakeholder in the company, since your loan will be paid off with interest.
What Happens When a Company Dissolves
In an event the company goes bankrupt, you would think the owners get paid first. However, contrary to that, it is the creditors and lenders who get paid first. So, bond investors will be settled first in case of dissolution.
A run-down table on Equity Market Vs. Debt Market
|Ownership of the Company
|Most cases, yes
|How it Pays
|Dividends, sell-offs on stock market
|Rate of Interest on the loan
|Risk on principal amount
|No (unless real-estate bonds/ corporate bonds are in question)
Debt Market Vs. Equity Market: Who is What for
For those with a moderate risk appetite, debt instruments are recommended. However, one must read bond papers carefully.
For those who are hoping to grow their wealth overtime and have a risk tolerance, they could opt for equities.
Difference between Equity and Debt Market: End Note
There is quite some difference between debt and equity, and both can be useful avenues to generate wealth. There is no-one-size-fits-all, you should analyse your financial goals and risk appetite before making a decision on investment-related matters.