What are Equity Investments - Types, How to Invest?

What is Equity?

Equity investments are market-linked investments that do not offer assured or fixed returns but are dependent on the underlying asset’s performance. In the case of equity investments, the amount is invested in equity derivatives and stocks of unlisted or listed companies.

While non-equity investments are not always affected by market movements, the performance of equity-based investments is dependent on market movements and also carries a significant amount of risk.

What are the Types of Equity Investments?

Equity investments are a broader term consisting of various investment options. Each investment option comes with its own benefits and risks. Given below are the major equity investment options available -

• Shares - Shares are the units of ownership of a company. These are units of ownership that the company issues in the market to generate capital from investors. People investing in these shares are known as shareholders. These shares are traded on stock exchanges like NSE and BSE. The difference between the purchase price and the sale price determines the profits from investment in shares.
• Equity Mutual Funds Investment - A mutual fund pools funds from multiple investors to invest in assets like stocks or bonds. An equity mutual fund focuses on listed market securities and is suitable for investors with limited stock knowledge or time. It spreads risk by diversifying across companies and sectors, reducing the impact of individual stock movements. While not risk-free, the professional management, transparency, and ability to invest small amounts regularly make equity mutual funds an ideal option for those with limited market understanding.
• Futures and Options - In addition to the traditional cash market for buying and selling equities, investors can also engage in equity trading through the derivative market. Derivatives derive their value from underlying equity assets and include futures and options contracts.
  Futures and Options (F&O) contracts enable investors to buy or sell the underlying stock at the current price with delivery deferred to a future date. While futures contracts require both parties to execute the agreement at a specified date, options contracts give the investor the right, but not the obligation, to execute the agreement at a predetermined price.
  As derivatives, the performance of F&O investments relies on the underlying equity's performance, whether it's a stock or an index. Investors use F&O contracts to speculate on price movements or hedge existing investments. These leveraged products offer the potential for higher returns but also expose investors to higher risks, as they allow trading in large quantities with only a small margin deposit.
• Arbitrage Schemes - Arbitrage in the stock market refers to the process of selling or purchasing the same stock at the same time but on different exchanges to benefit from the differential price opportunity in different markets. It can be difficult to spot arbitrage opportunities for individual investors. However, you can invest in arbitrage mutual funds.
  Arbitrage funds belong to the category of equity-oriented hybrid funds, investing in equities, equity derivatives (like F&O), and diverse debt/money market instruments. They aim to capitalize on price disparities across exchanges by simultaneously buying and selling securities.
  These schemes typically operate in both the equity and derivative markets, guaranteeing profits regardless of market direction. However, it's important to note that this investment strategy often yields narrow net margins per transaction, considering charges such as securities transaction fees.

What are the Risks Associated with Equity Investment?

Every market-linked investment is associated with some amount of risk. Risk indicates the possibility of a loss due to a variety of factors that can affect the performance of the investment. Below are some of the risks associated with equity investment -

• Market Risk - Market risk refers to the potential of incurring losses due to market factors. Market risk is also known as systematic risk, as it largely depends on macro factors and not on a specific industry or country. Market risk affects all industries, it can only be mitigated to a certain extent by diversifying the portfolio.
• Liquidity Risk - Liquidity risk is the risk of selling an investment at a lower price due to its ability to be sold easily in the market at a fair value as and when required. Many mutual funds retain the possibility of investing a portion of their assets in some debt and money market instruments.
• Performance Risk - Equity shares or equity mutual funds invest in individual stocks. These stocks may or may not perform as per expectations. This type of risk affects both individual stocks as well as the entire sector. The ideal way to mitigate performance risk is to diversify across themes, industries, and market capitalizations.
• Social/political/legislative factors also affect a business’s performance. For example, if a country promotes its domestic industry and increases barriers to entry of foreign companies, it will result in better performance for specific industries.
• Currency Risk - Currency risk, also known as exchange rate risk, stems from fluctuations in exchange rates between currencies. Investors investing in foreign equity markets are more prone to this risk. Additionally, businesses heavily reliant on global operations, such as those in the pharmaceutical or IT sectors, face exchange rate risk due to their significant presence in foreign markets.

One prevalent strategy to manage this risk involves maintaining a cash reserve or holding highly liquid assets. This allows investors to adjust their allocation to offset changes in exchange rates or other currency-related risks faced by equity or equity mutual fund investors. These risk mitigation practices are commonly referred to as hedging techniques.

When Should You Invest in Equity?

There are various factors that affect an individual's suitability for investing in equity markets. Given below are some factors that you must consider before investing in equity markets -

• Risk-Taking Ability - Individuals planning to invest in equity instruments need to have a higher risk-taking capacity. Success in equity investing depends on knowledge and skill. But for those short on time or expertise, equity mutual funds offer a way to earn decent returns with less risk.
• Investment Horizon - Another crucial trait is the capacity to remain invested for the long haul. Investors must grasp that equity investments often involve short-term volatility, leading to significant fluctuations in value. During challenging periods, it's essential for investors to maintain their position, as historically, equity markets have consistently trended upward over the long run.

How to Invest in Equity Schemes?

Before making any investment decision, it's crucial to carefully evaluate your financial objectives, risk tolerance, and investment timeline. We can broadly categorize investors into two categories, i.e., new entrants and seasoned investors.

For New Investors:

Lack of capital, time for constant monitoring, or expertise in selecting individual stocks can make individual investors wary of investing in the equity market. Consequently, they often opt for equity mutual funds. However, with various types of equity funds available, choosing the most suitable one can still pose a challenge. Hence, it's advisable to select funds based on your investment horizon, risk tolerance, and prevailing market conditions.

For Seasoned Investors:

As an experienced investor, you likely have a good understanding of how these funds operate. Nonetheless, it's important to leverage your expertise to mitigate risks effectively. Your market knowledge can help you select the right scheme, potentially leading to higher returns compared to other funds.

What is the Taxability of Equity Investments?

The returns on equity investments are subject to tax. Given below is the tax liability on equity investments -

Capital Gains Tax - If you hold the investment for a period of more than one year, then it is termed as long-term capital gains. Any long-term capital gain above Rs.1 lakh is taxed at @10% without any indexation benefits.

If you hold the investment for a period of upto 1 year, then it is termed as short-term capital gain, Any short-term capital gain or STCG earned by you is taxed at flat @15%.

Hope this guide helped you gain deeper insights into what is equity and the types of equity investments, how to invest in equity, and its taxability. Are you also planning to invest in equity schemes? With so many equity investment options, selecting the right one according to your financial situation can be tricky. Don’t worry! Our tax experts are here to help you find the right equity investment scheme as per your needs while making sure you achieve maximum tax savings. Get tax consultation now!