Should I invest in equity or debt funds?
Generally, debt funds are considered safer than equity funds because they primarily invest in fixed-income securities with lower volatility. However, the level of safety depends on the credit quality and maturity of the underlying securities.
Generally, debt funds are considered safer than equity funds because they primarily invest in fixed-income securities with lower volatility. However, the level of safety depends on the credit quality and maturity of the underlying securities.
Debt financing can offer the means to grow without diluting ownership, while equity financing can provide valuable resources and partnerships without the pressure of repayment schedules.
Is Equity Financing Better Than Debt? The most important benefit of equity financing is that the money does not need to be repaid. However, the cost of equity is often higher than the cost of debt.
The primary advantage of investing in equity is that it can generate high returns in a short time in comparison to other investment options like Bank FDs. Presently, the equity market is reaching all-time highs as it recovers from the Covid-19 setback of 2020.
Since Debt is almost always cheaper than Equity, Debt is almost always the answer. Debt is cheaper than Equity because interest paid on Debt is tax-deductible, and lenders' expected returns are lower than those of equity investors (shareholders). The risk and potential returns of Debt are both lower.
Indeed, debt has a real cost to it, the interest payable. But equity has a hidden cost, the financial return shareholders expect to make. This hidden cost of equity is higher than that of debt since equity is a riskier investment. Interest cost can be deducted from income, lowering its post-tax cost further.
Risk Factor: Understand the risk potential for both types. Debt funds offer less risk, a lower chance of capital loss, and reduced potential returns. In contrast, equity funds involve more risk, a higher chance of capital loss, and greater potential returns.
It is a good option for investors seeking stability, regular income, and lower risk. However, if an investor wants to take higher risks and earn higher returns, it is not a good option, as it offers lower returns than equities. Are debt funds safer than FD?
Debt financing can be riskier if you are not profitable as there will be loan pressure from your lenders. However, equity financing can be risky if your investors expect you to turn a healthy profit, which they often do. If they are unhappy, they could try and negotiate for cheaper equity or divest altogether.
Why is debt financing bad?
The main disadvantage of debt financing is that interest must be paid to lenders, which means that the amount paid will exceed the amount borrowed.
"Debt" involves borrowing money to be repaid, plus interest, while "equity" involves raising money by selling interests in the company. Essentially you will have to decide whether you want to pay back a loan or give shareholders stock in your company.
The 100% equities strategy can prove to be an ideal stock market strategy to focus fully on the most rewarding asset class and make hefty profits along the way.
The concept of the "safest investment" can vary depending on individual perspectives and economic contexts, but generally, cash and government bonds, particularly U.S. Treasury securities, are often considered among the safest investment options available. This is because there is minimal risk of loss.
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Debt financing often moves much quicker. Once you're approved for a loan, you may be able to get your money faster than with equity financing. Will you give up part of your business? Giving up a percentage of ownership is the biggest drawback to equity financing for many business owners.
While average ratios, as well as those considered “good” and “bad”, can vary substantially from sector to sector, a return on equity ratio of 15% to 20% is usually considered good.
Dividends. One of the most straightforward ways for companies to pay back their investors is through dividends. A dividend is the distribution of some of a company's profits to its shareholders, either in the form of cash or additional stock.
In general, if your debt-to-equity ratio is too high, it's a signal that your company may be in financial distress and unable to pay your debtors. But if it's too low, it's a sign that your company is over-relying on equity to finance your business, which can be costly and inefficient.
Advantages of Equity Financing
Investors typically focus on the long term without expecting an immediate return on their investment. It allows the company to reinvest the cash flow from its operations to grow the business rather than focusing on debt repayment and interest.
What is a good debt-to-equity ratio?
Generally, a good debt to equity ratio is around 1 to 1.5. However, the ideal debt to equity ratio will vary depending on the industry, as some industries use more debt financing than others.
| Scheme Name | Expense Ratio | 1Y Return |
|---|---|---|
| SBI CRISIL IBX Gilt Index - June 2036 Fund | 0.28% | 9.37% p.a. |
| Kotak Nifty SDL Jul 2033 Index Fund | 0.2% | 9.13% p.a. |
| UTI CRISIL SDL Maturity April 2033 Index Fund | 0.16% | 9.11% p.a. |
| Bandhan CRISIL IBX 90:10 SDL Plus Gilt- April 2032 Index Fund | 0.16% | 9.05% p.a. |
So, ideally, the best time to invest is when interest rates are falling or are expected to decline. When the interest rates are going down, the bond prices rise, and consequently, the NAV of debt funds also increases. As a result, debt fund investors benefit.
Among the various types of debt funds available in the market, one of the most popular has been the Monthly income plan or MIP. While MIPs as a debt product gives higher returns than traditional bank FDs, they are not an assured return product, as is normally perceived.
The Cost of Equity is generally higher than the Cost of Debt since equity investors take on more risk when purchasing a company's stock as opposed to a company's bond.
