The term direct equity refers to investment in the stock market directly. To directly invest in the stock market, you need a demat and trading account. This account allows investors to buy shares/stock of the company directly from the stock market. To know more about equity, read our complete guide on Direct Equity which covers the types of equity investment, advantages and limitations.
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What is an Equity Investment?
In the context of the stock market, equity refers to shares of the company. Every person who holds the company’s share as a shareholder becomes a partial owner of the company. In simple words, it is the total amount of money that the shareholder receives if all the company pays off the debt, and liquidate its assets.
Equity investment refers to investment in company stocks, where the investor earns profit through stock price appreciation and dividends. Apart from monetary benefits, shareholders also get voting rights in the critical matters of the company. Therefore, they are the partial owners of the company to the extent of the shares held by them.
When a company needs funds, it issues shares for business expansion. They approach investors through IPO (Initial Public Offering). It is the primary market where the company issues shares for the first time for subscription. Post subscription, they get listed on the stock exchange for regular trading.
Investment in equity has been quite popular among investors as it can generate inflation-beating returns. At the same time, they expose the individual’s portfolio to high risk. Hence, every individual must understand their risk-taking capacity before they decide to invest in the stock market.
Types of Equity Investments in India
Equity investments are market-linked, and their returns depend on the performance of the underlying asset. Equity investments are classified into several categories, where each category has its own risk and reward. The following are the types of equity investments in India –
The term shares mean they are the units of partial ownership of the company where you invest in. Such investors are known as the shareholders of the company. The shareholders are eligible to receive the profits distributed by the company in the proportion of their shareholding pattern,
The shares are traded on stock exchanges like National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). Investment in shares has the potential to generate high returns where the risk is equally high.
2. Equity Mutual Funds
Mutual funds are funds where it collects and pools money from multiple investors and invested in various debt and equity instruments. Equity mutual funds are those which primarily invest their assets in equity shares of different companies. Equity mutual funds are for those investors who don’t have the time and/or knowledge to trade in individual shares. Moreover, equity mutual funds have the added advantage of professional fund management and transparency. Also, it allows investors to invest regularly in small amounts through SIPs.
Equity mutual funds can further be classified into various categories based on their market capitalization –
3. Futures and Options
Investors can also trade in equities through the derivative market. A derivative is financial security, where its value is derived from the underlying security. In a derivative market, investors can trade in futures and options.
Both the investment instruments allow investors to enter into a contract where the investors should buy or sell the underlying assets at a current price and defer delivery to a predetermined future date. In the case of a futures contract, both parties are obliged to execute the agreement at a specified date. Whereas, in options, the investor has the right but not obligation to execute the agreement as per the price anytime during the contract.
Usually, F&O contracts are used by advanced investors and traders to earn by speculating on the price movements of the underlying asset. Sometimes, it is also to hedge the current investment. Moreover, F&O contracts have an expiry of up to 3 months.
4. Arbitrage Schemes
Arbitrage in the stock market refers to buying and selling the same stock at the same time on different stock exchanges. This allows earning profit from the price difference available in different exchanges. As an individual investor, one may invest in arbitrage mutual funds to participate in arbitrage trading opportunities. These funds primarily invest in equity, equity derivatives, debt or money market instruments.
5. Alternative Investment Fund
Alternative investment funds are a relatively new concept in India where investors can invest in equity through alternative funds. They are privately managed investment funds pooled from domestic and foreign investors. They primarily invest in hedge funds, venture capital, managed futures, private equity, etc.
What is a Direct Equity Investment?
Direct equity investments refer to those investments made by investors directly in the stock market for buying the company shares/stocks. In other words, the money invested in the shares of the company is termed equity. In legal terms, the investor is buying partial ownership of the company to get the voting rights. Investors require a demat account for trading in shares. This account can be a personally managed account, or a broker/dealer can manage it.
Some investors who understand the working of equity markets can directly purchase stocks/shares of the company and plan their investment portfolio. Also, they can find the right balance between risk and returns. On the other hand, some investors can find it difficult to understand business fundamentals and technicals. Hence, they should invest in direct equity under an expert’s guidance.
Who Should Opt for a Direct Equity Investment?
Direct Equity Investment is suitable for investors who are willing to take risk and more importantly have the necessary know-how. Investment in direct equity requires adequate knowledge and skill. Market linked investments are not suitable for investors who have low-risk tolerance levels. Hence, investors with limited time or experience can invest in equity mutual funds instead.
Direct equity investment requires investors to stay invested for the longterm. Investors need to understand that stock markets are volatile, and therefore, equity investments can lead to substantial swings in the short term. It is advisable to stay invested in tough times as the markets move upwards historically in the long run. Also, direct equity offers attractive returns to the investor at a commensurate higher risk. Hence, if you can embrace the market volatility, stay invested for the long term, and have the right pick for investment, you can maximise growth in your investment portfolio.
What Are The Risks Involved With Direct Equity Investment?
While there are potential benefits when investing in equities, there are risks like other investments. The associated risk will directly impact the company where the stock prices rise or fall. As a result, investors can gain or lose the certain value of their investments. The following are the risks involved while investing in equities –
The market risk is also called systematic risk. This means it has a direct impact on the company’s stock. The share prices fall or rise based on market fluctuations. Therefore, investors can lose some or all of their investment value due to market risk.
Any up or down in the company’s performance can also affect the equity stock price. Simply put, if the company is performing well, the stock prices rise. On the other hand, if the business faces losses, a downfall in revenue or any problems within the company, the stock prices will fall. Therefore, investors must analyse the company’s financial strength before investing.
Before investing in company stock, you must also check how solvent the company is. Companies with high debt may find it challenging to pay bills, repay their debt, cut back on dividends, or, in the worst case, may go bankrupt. All these factors can have an adverse effect on the company’s stock price. However, many investors do not consider this factor while investing. Thus, investors end up having investments which cannot be sold quickly.
Just like regulations surround the company, there are tax rules that govern the company. The government tends to change the tax rules based on economic needs. Therefore, any change in taxation can affect the stock price. For instance, if the sector in which you purchased a stock, a new tax is levied, and the existent tax is increased, the stock price may fall and vice versa. Moreover, the government controls this aspect, where the companies and investors can’t do anything.
Different sectors are governed by different regulatory bodies and involve the government too. So, any change in the regulations by the regulator or government can impact the companies in particular sectors, resulting in a rise or fall in stock price. For instance, if a pharmaceutical company loses any drug manufacturing licence due to regulatory effects, it will directly affect its profit and stock price.
Interest Rate Risk
The interest rate changes from time to time, which can positively or negatively affect the stocks depending on which direction the economy is heading. If the interest rates increase, the companies have to borrow money at a higher rate which can reduce profits and affect the stock price. On the contrary, if the interest rate is decreasing, this can indicate an economic slowdown, where there is lower demand in the market. This leads to businesses suffering losses which can impact the stock price adversely. Therefore, having a balanced interest rate regime is healthy for a stock market. Any drastic shift in interest rates can be a sound alarm.
Inflation means an overall increase in the price of commodities and products in the economy. When inflation rises, the company must spend more to procure the raw material, which can increase production costs. Also, it can reduce the company’s purchasing power, impacting its profitability. Thus, it causes a drop in the share price.
When the company issues a bond and won’t be able to pay interest or repay the principal amount at maturity. In other words, credit risk is when the company defaults the payments. Thus, it will have an adverse effect on the share price.
Social and Political Risk
A company’s return can be affected due to the country’s political changes or instability. For instance, Tata Motors shifted its Tata Nano plant from West Bengal to Gujarat due to political reasons, which cost a lot of money to the company.
Currency/Exchange Rate Risk
Many companies that deal across nations and are involved in export or import may face a problem when the dollar price increases. Therefore, currency rate fluctuations may increase the risk in these companies.
They are the prominent market players who can also affect the particular stock price and stock market performance as well. If the FII/DII investment decreases in a company, i.e. they start selling stocks. This will adversely affect the share price of that company.
Advantages and Disadvantages of Investing in Direct Equity
- Probability of High Returns: Investing in direct equity has the potential to generate higher returns in comparison to other investment avenues. Investors can earn not just through dividends but also capital appreciation, which helps in wealth creation in the short and long run.
- Easy Investment: The process of Investing in direct equity is very simple and easy. The investor has to set up a Demat Account through a stockbroker to buy and sell stocks within seconds. Also, they can choose to buy shares through NSE or BSE based on their choice.
- Regulatory Body: The Indian stock market is well regulated and governed by the Securities and Exchange Board of India (SEBI). Also, SEBI guards the stakeholder’s interests or company, and they are the face to secure any fraudulent activity by a company or shareholder.
- Market Risk: Even though investing in direct equity yields high returns to investors, it can also be equally risky compared to other investment avenues. There are chances that the investor can lose their entire corpus by investing in direct equity if they lack the necessary knowledge
- Volatility: The stock markets are very volatile and dynamic in nature. The equity share prices might spike and plunge multiple times in a single day, and these fluctuations are very unpredictable.
- Performance Risk: The performance of direct equity depends on the market performance. In other words, direct equity is a market-linked instrument that might not perform as per the investor’s expectations. Hence, this performance risk can affect the individual stock or stocks across the sector.
- Liquidity Risk: Sometimes due to liquidity risk, investors might have to sell their shares at a lower price than their fair market value.
- Social and Political Risk: Any changes in the social and political issues of the country will affect the stock market and businesses. For instance, when the government announced to support ‘Make in India’ products, the homegrown businesses have benefited, which has delivered a better performance for investor’s investments.
Investment in direct equity has its advantages and limitations. Also, investors who have skill and experience and are aspiring for higher returns can invest aggressively in direct equity. Further, these investors understand the risk of investing in direct equity.
Those who are not market experts can pick a good quality stock, stay invested for the long term to maximise their returns. Therefore, investors must understand their risk tolerance levels before investing in direct equity, which ensures they make sound financial decisions.