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Is it safe to invest in equities?

  • Amit Kumar
  • Oct 01 2021
  • 9 minutes
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Investment in equities is one of the most attractive investment options as it has the potential to generate the highest returns over a long period of time. However, for the average Indian investor, investment in stock markets is often filled with apprehension and the fear of losing their capital rather than making more money. 

Over the last year itself, we have seen the Indian stock markets crash due to the pandemic and then rise to the highest level that it has ever seen. Indian stock markets are also perceived to be the best performing markets in Asia. This makes it an attractive investment option for the investors but the risks associated with this investment often hold back the majority of Indian investors.

It is, therefore, important to understand the nuances of investment in equities or stock markets to maximize their earning potential. Below are a few details related to investment in equities that will help the investors make efficient investment decisions. 

What is the meaning of investment in equities?

For the average investor, investment in equities refers to investment in the shares or stocks of any company whose shares are listed on the recognized stock markets. However, there is more to the investment in equities. It includes equity mutual funds or equity-oriented hybrid mutual funds, futures and options, and arbitrage schemes. These investment options are usually able to generate good market returns, especially in the bull market.  

What are the risks of an investment in equities?

Investment in equities is subject to many types of risks. These risks can lead to lower returns or can even wipe out the capital investment of the investor if they are not prudent in their investments. The various risks associated with an investment in equities are mentioned below.

a. Liquidity risk

Liquidity risks are when the company is unable to meet its commitments in the form of dividends. This can be on account of various issues like solvency issues or reduction in the funds’ availability on account of various business factors. Such liquidity risk will result in the funds being stuck and the redemption value of the investment may also be reduced. 

b. Market risk

The returns of the investment in equities are highly volatile and are subject to market risks. These risks reduce the value of the investment if the investor exits at the time of slump. Such a reduction in the value of the investment is the result of market risk.

c.Inflation risk

Inflation is quite common in developing countries and is referred to as the general increase in the prices of all the goods and services in the country. This increase in the inflation rate has a direct impact on the bottom line of the company. The company will have to allocate more resources towards their end products and the increase in costs will eat away the revenue. This negative impact on the revenue of the company will snowball into their share prices leading to a reduction in investor’s wealth. 

d. Political risk

Sometimes a change in the political scenario of the country or in the policies of the Government may have a detrimental effect on the revenue of the company eventually reducing their share prices. This risk is known as the political risk and is a major factor to be considered especially in developing countries.

e. Currency risk

Currency risk is the fluctuation in the currency rates of the country that can reduce not only the foreign reserves but can also reduce the revenue of the company. Currently, the dollar rate is among the highest levels and has negatively impacted many companies that are heavily dependent on imports. 

f. Concentration risk

Concentration risk is when the revenue or the performance of the company is highly dependent on a single entity (vendor, customer, etc.) or a single sector. It can also be reliant on a single country. Such excessive reliance on a single factor can put the revenue of the company in serious jeopardy. 

Who are the target investors of the equity market?

Investment in equities has the potential to generate maximum returns as against any other investment type or class. However, investment in equities is also among the riskiest investment options. These risks can often keep the majority of investors away from equities.   The target investors for equity investment, therefore, are those investors that have a high risk appetite. 

Equity investments are able to generate maximum returns when the investors stay invested for the long term. In the short term, many times the equity markets have wiped out investor wealth but in the long run, equity markets have always increased. To sum it up, equity markets are ideal for investors with a long term horizon and having a higher risk appetite. 

What are the tips to have a successful equity portfolio?

Having a successful equity portfolio is dependent on many factors. Investors have to navigate through these factors to have a quality portfolio that can generate good returns for them and meet their investment goals. 

a. Diversification 

Diversification is the key to having a successful portfolio. Investors have to ensure that they invest in good quality stocks that have a proven track record of generating sufficient returns. Diversification in equity stocks can be achieved by investing in good quality stocks from different sectors as well as companies. 

b. Long term investment horizon

Stock markets are subject to market volatility and market fluctuations in the short run are capable of wiping off investors’ wealth completely. However, stock markets have proved to be a huge wealth creator in the long term. Hence, it is essential to stay invented for a long term horizon to maximize the gains in equity investment.

e. To get expert assistance whenever needed

The majority of investors in the stock market are novices and do not usually have a thorough knowledge of the workings of the market. They often get carried away with current trends and short term market volatility. This may lead to wrong or unfavorable decisions reducing the net income or returns from their equity investment. In such cases, it is important to take the benefit of professional help i.e., experts in the field that can help create a good portfolio for the investors.

f. Do not make biased investment decisions 

In many cases, investors tend to make emotion-based decisions regarding their equity investments. Hasty decisions can lead to losses or reduction in the portfolio value. It is often observed that investors focus on short term gains and miss out on long term benefits due to biased investment decisions. It is, therefore, necessary to keep emotions out of the decision making process. 

g. To get maximum information about the company

Another important factor to be considered while making the investment decision is getting all the information about the company. Investors should look at the basic financials of the company. The company should have a sound business model that can weather every market condition.

h. Awareness of risks of offshore investing 

Offshore investing has been an attractive investment option, especially for aggressive investors. It has the potential to maximize the investors’ wealth. However, investors have to be aware of the risks involved in such investment to protect their interests. 

i. Awareness of risks of investing in private stocks

In some cases, investors also invest in the stocks of private companies which means their stocks are not listed on any recognized stock exchange. Investing in good quality private stocks can be profitable but they do come with many risks. Some of these risks are liquidity risks, huge capital investment, etc. being aware of such risks and making a well-informed investment decision will help them maximize their portfolio.

j. Periodic performance review of the investment 

Just like it is important to buy good quality investments at the right time or the most opportune time, it is equally important to review the portfolio regularly. This will ensure that investors can exit the stocks that may no longer be cost-effective or may have better investment options in that particular segment.

k. Investment to be in line with risk appetite

Another important factor while selecting an investment is being aware of the risk appetite and making an investment in line with such risk parameters. If a risk-averse investor has invested in high-risk stocks (mid-cap stocks, small-cap stocks, etc.), it will not agree with their risk parameters and will not help in meeting their investment goals.   

Conclusion

An investor’s portfolio usually needs to have a good mix of equity and debt to have a balanced and diversified portfolio. Investment in equities, although risky, has the ability to provide the maximum boost to a portfolio. However, it is prudent to be aware of the risks of such investment and make well-informed investment decisions to ensure that the portfolio is not negatively impacted.

FAQs

1. What are equity-oriented hybrid funds?

A. Equity-oriented hybrid funds are mutual funds that invest in debt and equity instruments. However, the dominant investment in the fund (minimum 65% of the fund) is in equity and equity-related instruments.

2. What are the types of equity funds based on market capitalization?

A. Equity mutual funds are classified based on many parameters like market capitalization, investment objective, etc. The types of equity mutual funds based on market capitalization are,

  1. Large-cap fund (investment in the companies with a market capitalization over Rs. 20,000 crores)
  2. Mid-cap fund (investment in the companies with a market capitalization from Rs. 5,000 crores to Rs. 20,000 crores)
  3. Small-cap fund (investment in the companies with a market capitalization less than Rs. 5,000 crores to Rs. 20,000 crores)

3. How are dividends received from equities taxed?

A. The dividends received from equities are taxed in the hands of the investor at the applicable income tax slab rates.

4. Does investment in equity make the investor a part-owner of the company?

A. Yes. Investment in shares or stocks of a company entitles the investor to part ownership of such a company. The returns on the investment are the share in profits of the company which is proportional to their investment.

5. How to invest in equity shares taxed?

A. Taxation on equity shares is in the form of capital gains and taxation in dividend income. The details of the same are tabled below.

Type of taxation Period of holding Tax rate
Short term capital gains Less than 12 months 15%
Long term capital gains More than 12 months 10% (without indexation)
Tax on dividends Not applicable Taxed as per applicable slab rates

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