What is Equity?
Equity is the ownership stake you hold in a company. When you have equity, you own a piece of that company. Think of a pizza cut into 100 pieces. If you have 10 pieces, you have 10% of the pizza. It’s the same with companies. They are split into smaller units called shares. When you own their shares, you gain partial ownership in the company.
Equity is your share of a business. If the business does well and grows, the share value increases. If it does not, the value can degrade. This means investing in equity can be both favourable and unfavourable. The reward you get back depends on how the company performs.
How Equity Works in the Stock Market?
When a company wants to increase its share capital, it can sell parts of the company to investors through the stock market. People can buy these parts of the company through a brokerage platform, which helps with buying and selling stocks which is known as equity trading. When they invest in shares, they become owners of a small part of the company. If the company does well and demand for its shares rises, the price of your equity holding of the company goes up, and you can either continue holding it or sell it for a profit. In return, you receive a fraction of the company’s profit based on the number of shares held by you.
Having ownership of a company differs from providing a loan. A company that borrows money from a bank is required to pay it back with interest, regardless of the circumstances. That is borrowing money. Shareholders, on the other hand, are owners and come below the creditors in the repayment ladder. Meaning, if a company winds up, the equity holders will be paid if any amount is left after debt settlement. Shareholders take a bigger risk, but they also get a share in the company’s positive outcomes.
Types of Equity every Investor should know.
Equity is not everything. Here are the common kinds of equity you will see:
- Common Equity: Common equity, also known as Ordinary Shares, is the simplest kind of equity. When people talk about buying stocks, they are referring to common shares, which provide you the right to vote on what the company does. You get a share of the profits. If the company goes out of business, people who own common shares get paid last.
- Preferred Equity: Preferred equity, also known as Preference Shares, is different. Shareholders with preferred shares receive pre-determined dividends before common shareholders. They also get their money back before shareholders if the company closes. However, people who own shares do not get to vote on what the company does.
- Sweat Equity: Sweat equity is when you earn equity by working, not by paying money. For example, if someone starts a company from nothing, they own Sweat Equity in that company. They own part of the company because they put in a lot of time and effort, not because they bought shares. This person has equity in the company because of the work they did, not because they paid for it. They have sweat equity in the company.
Equity vs Debt
The key differences between equity and debt are mentioned below:
| Feature | Equity | Debt |
| Meaning | Ownership in a company | Money borrowed by a company |
| Return | Depends on the company can vary | Fixed and guaranteed |
| Risk | Higher Risk | Lower Risk |
| Voting Rights | Yes | No |
| Share of profit | Dividends | No share of profit |
| Example | Shares, Stocks | Bonds |
Why Equity is Important in Investing & Wealth Building
Equity is considered an optimal way to build wealth over a long-term period. The return on equity is often greater than that of fixed-income and debt assets.
When invested in equity, your investment has the potential to grow over a long period. The reason behind this is called compounding. As the company does well, the value of your equity shares goes up. If you put your dividends back into equity, those earnings will also start to make money.
In the long run, this can grow substantially. Even small investments can grow into a good sum over time.
Equity is a popular investment also because it helps your money keep its value when inflation rises. Prices often rise as time goes by. What costs ₹100 today may cost ₹150 in ten years. Your money may not grow if it stays only in your savings account. Equity has a better chance of growing in value even after you account for inflation and rising prices.
How to Invest in Equity: Beginner-Friendly Guide
Investing can be complicated for a beginner. So, here are a few simple steps which can help you gain confidence.
They are mentioned below :
- Step 1. Create a Demat and Trading Account: Your shares are held digitally in your Demat account. A trading account enables you to buy and sell securities easily. You can open both through any registered stockbroker or investment app in India.
- Step 2. Analyse your goals and risk: Before choosing to invest, you should analyse your personal goals, meaning what your expectations from the investment are. And also be conscious of the degree of risk that you can handle.
- Step 3. Shortlist your options: Shortlist your funds based on the technical analysis of market capitalisation, returns, P/E ratios, etc. Also, remember that the standard metrics vary from industry to industry. You can use various Nifty indices to gauge standard performances across industries.
- Step 4: Analyse your option: Out of the shortlisted stocks, analyse the company performance through their quarterly and annual reports. Not only market performance but also company health and business efficiency determine how a company will perform in the long run.
- Step 4. Make a decision: Once you have analysed and selected your option, you can make your investment. A long-term investment for 5 to 10 years can help achieve better growth. Over the long run, it has consistently rewarded patient investors who invest in equity.
As a beginner, choosing and investing in individual stocks might be difficult due to limited knowledge, experience, and funds. Diversifying through equity mutual funds, index funds, etc., can help begin the equity investment journey.
Risks in Equity Investing & How to Manage Them
The various risks in equity are as follows:
- Market Volatility: Market volatility is something investors have to deal with in the case of equity investing. Stock prices can change fast because of economic news, global events or when investors change their minds. This makes the future outcome of your money uncertain.
- Company Specific Risk: The company you invest in might not do well. It could even go out of business. In that case, your money may be at risk of partial or total loss.
- Inflation Risk: Inflation risk needs to be taken into account, too. If the money you make from stocks does not keep up with inflation, your money is actually worth less over time. This is true even if it looks like you are making money.
- Liquidity Risk: Sometimes you might not get a buyer to sell your stocks. Or even if you do, you might have to sell it at a lower price and incur a loss on it. This is called liquidity risk. It can be a problem if you need to get your money out urgently.
- Concentration Risk: Concentration risk is when you put a lot of money into one company or one type of business. Market volatility and company-specific risk can be a problem if you do this. If that company or business does not do well, you could lose a lot of money because you have invested too much.
The measures that can be taken are mentioned below:
- Stay invested for the long-term: Market ups and downs are normal in the investment market. Staying invested for the long term helps balance out market ups and downs.
- Diversify your portfolio: This means you should classify your money across companies and sectors. You should also invest in types of assets. This protects your overall investment if one investment doesn’t perform well.
- Invest through SIPs: A SIP is a structured and regular investment strategy. A fixed sum is invested per month. This way, you do not invest a sum at the wrong time.
- Choose fundamentally strong stocks: Research companies before you invest. Look for companies with financials and consistent profits. Also, look for companies with strong management. This will help you reduce the risk of investing in one company.
- Invest in stocks or funds: Stick to known sector stocks or large-cap mutual funds. These stocks and funds can be easily bought or sold at any time.
- Follow a plan: First, set your financial goals. Then stick to the investment strategy you decided on after analysing the market. You should be patient with your decision and continue to follow the plan to reach your goal.
Final Thoughts
Investing in equity is a way to increase your money over time. When you invest in equity, you actually own a part of a company. It offers faster growth compared to a regular savings account and debt investments. Due to its high potential, risk levels can also be high. A planned and diversified investment, based on nuanced research, can help you control the risk.
It does not matter if you start by investing an amount of money like ₹500 a month in a mutual fund or if you spend time learning about individual stocks. The key is to simply get started. The sooner you begin investing in equity, the longer your money gets to grow over time.
FAQs
Equity is a way to make money because you own a small part of the company. When you buy shares of a company, you have a piece of that company. The share value rises if the company’s performance is good. It is a way to make your money grow by being a part-owner of a business like the company.
Shares are a way that people can own a part of a company. When a company wants to let people buy a part of it, they divide the company into parts. These parts are called shares. The shares people buy are a type of ownership. Ownership of a company is not about shares; it is about other things, too, like private equity and preferred stock, which are also types of ownership.
The main types of shares are common shares (stocks that give people voting rights), preferred shares (claim on dividends and do not get voting rights), and sweat equity (ownership in a company because of the effort they put in, not because they paid money for it).
Equity is a riskier option than fixed deposits or bonds. This is because the returns on equity are not guaranteed. The prices of equity can fluctuate. There are ways to manage this risk. You can manage the risk of equity by diversifying your investments. Investing in equity for the term is also a good idea.
Beginners can start by creating a Demat and trading account, and then investing in equity mutual funds through a monthly SIP. This is a low-risk and affordable way to enter the stock market without needing to pick individual stocks.
Equity helps your money grow more than savings. It uses compounding to make your wealth increase over time. Your money can stay ahead of inflation with equity investments. Equity gives your money potential for long-term growth. This helps your wealth increase significantly.
