If you’re new to investing, you may have heard of the terms debt and equity investments. What are they? How do they work?
Today we’ll define both of these terms and their distinct differences to you as an investor. Depending on your current financial situation, you may favor one over the other as an investing strategy.
If you’ve ever wondered to know the difference between equity investment vs debt investment, you’ll want to stick around, pull up a chair, and a cup of coffee as we dive into the details.
What Is Equity Investment?
Equity investments are a broad term for investing in stocks. These securities provide the opportunity to purchase equity in a company. Traded on the New York and other stock exchanges, this is the type of investing most people think about when they envision investing their money.
Equity investments have a higher risk. Stocks and the market have volatility, which adds risk to your investment. With that volatility, there is a chance for both high risk and high reward.
Equity investments include:
- Mutual Funds
- Real Estate
- Real Estate Investment Trusts (REITs)
The fluctuation of price changes is what draws most people to equity investments. If you look at the list above, you’ll notice that the prices of these can go up or down depending on the market. It’s that element of high reward or return on investment that excites some investors when it comes to equity investing.
What Is Debt Investment?
Debt investment is a broad term for loaning money to a person, business, or government institution at a fixed rate of return. Due to the fixed rate of return, debt investment is less risky than equity investment.
There are benefits and drawbacks to debt investment. If you loan $1,000 to a company, you can feel assured that your rate of return will always be the same, based on the agreed-upon interest factored into the loan.
Debt investments include:
- Savings Accounts
- Certificates of Deposit (CDs)
- Corporate Bonds
- Government Bonds
- Municipal Bonds
If the company uses your $1,000 and turns it into $10,000, you’ll only get the agreed-upon rate of return. Your return on investment isn’t tied to the company’s performance. If you’re looking for a safe return, this is one way to get it.
The only downside to debt investments is that there is always the chance that the person, company, or government will default on the loan and not be able to pay you back.
Since debt investments have a specific rate of return, the return on investments can be greater with equity investments.
Equity Investment vs Debt Investment
Equity investment and debt investment are two forms of investing that people use to build wealth. Most times, your age will determine what type of investment you may favor.
When you purchase equity investments, you are buying stock or ownership of a corporation that has gone “public” offering shares of their business in exchange for capital. Many people consider this regular investing.
With equity investments, you are always riding the wave of a corporation’s stock price, which can fluctuate from day to day or even minute to minute. Due to the nature of this type of volatility, there is an inherent and implied risk with your investment.
When you purchase debt investments, you are loaning your money to a business or government entity with an agreed-upon rate of return. This type of purchase is a sound investment that has less implied risk.
Let’s look at a scenario that will help break down the distinct differences in equity vs debt investments. In this scenario, the same investor will get the same opportunity: to loan Google $6,000 for capital.
Imagine you spend $6,000 on Google stock that is selling at $6 per share. You have bought 1,000 shares. Today that same $6 is worth $1,504! That’s a BIG return on investment. That’s the power of equity investments.
Now, imagine you have the opportunity to loan $6,000 to Google for an agreed-upon interest rate of 10%. Pretty good! You take that because it’s higher than other bonds offering 6%.
At the end of your arrangement, you would have gotten a $600 return. While this is a sound investment, with less risk, it has much less reward. That’s the difference between equity vs. debt investments.
In the second scenario, you have your rate of return. It doesn’t change. In the first, you take a gamble that can pay off huge or dissolve into dust.
Depending on how young or old you are will depend on how much risk your willing to take on. A diversified portfolio will usually have both types of investments.
Companies: Beware of the Shark Tank
If you’re a company that is looking to grow your business, you have options as well. You can choose to enter an agreement for capital contribution. That can involve risk, like an investor. One type of capital contribution involves debt investments, while another offers capital for equity in your business.
It’s essential to understand these distinct differences when receiving capital contributions to your business. Enlisting the help of a lawyer to help you read the fine print can help.
Equity vs Debt Investment: Which Is better?
When it comes to equity investment vs debt investment, there is no real clear type of investing that is better than the other. A diverse portfolio likely has both of these types of investments to safeguard against inherent and implied risks found in equity investing.
If you’re looking for more ways to grow your wealth and become a better investor, be sure to look around our blog.