Updated on: June 25, 2020 ; Investments
What is Equity?
Equities are one of the most popular and profitable investment avenues available. There are several ways in which an investor can participate in equity investing. We will cover the major ones in this article. But before that, let’s get an understanding of the meaning of equity.
Any company can have single or multiple owners. The ownership of the company is split into many equity shares. Now any person or any organization can own a number of these shares. The percentage of the total issued shares owned by a person determines his percentage ownership of the company. There are different classification of shares, that have different privileges. We won’t be covering those details in this article.
These shares could be held privately or traded publicly on an exchange. It is very easy to invest in these publicly traded companies through a very transparent process. Now it’s time to take a look at some of the widely popular ways to invest in equity. We will talk about six of those in brief.
1. Direct equity
You can directly buy and sell publicly traded shares of a company on a stock exchange. The two primary exchanges are the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). These exchanges handle millions of transactions daily (obviously, they are closed on holidays). You need to follow a few simple steps to start trading in direct equity. First, get in touch with a broker and set up a Demat and a trading account. Link it to your savings bank account. Complete a few KYC formalities. Once everything is set up, you can start investing.
Normally when we talk about investing in stocks, we refer to buying shares that are already listed and traded in the market. So, when you buy any shares on an exchange, you are buying it from another party who is selling those shares at the price at which the transaction takes place. We will not go into the details of how the order matching and price discovery here. This is called the Secondary market.
There is also a way to participate in the stocks of a company at the time of its listing. That means buying when the shares of the company are publicly traded for the first time. This is through a process called the Initial Public Offering (IPO). There are also ways to participate in the direct equity of unlisted companies, more on that later.
2. Mutual funds
We discussed the direct way of investing in shares of a company. To buy direct equity, you need to know the right company and the right price to buy. You might not be sure about it or might not have time to do the research before you make the decision. But you wish to participate in the equity market and want an expert to handle your portfolio. Then the most popular and affordable way is to invest through mutual funds.
Let’s take a look at how mutual funds work. Many investors who don’t want to actively manage their equity investments, will hand over their money to an expert to manage their investments. This expert (fund manager) will collect the money from different individual investors and create a big pool of funds. Then he will use this pool to invest in a portfolio of assets. In return, the fund manager will issue units to each of the individual investors based on the amount of money invested.
These units have a value attached to them, known as the Net Asset Value (NAV). This keeps changing every day based on the price movement of the assets in the portfolio. The fund manager will keep rejigging the portfolio as and when required while staying within the regulatory bounds. You, as an investor have no control over what changes he makes. You have to trust his skills in making the right choice for you. Please note, there will be a fee which the fund manager will charge for his services.
This was just a very basic explanation of mutual funds. There are a lot of Mutual fund companies available today. They offer many different types of schemes that an investor can choose from. This large collection of mutual fund schemes will confuse anyone. We will cover these in detail over several articles. To summarize, mutual funds are one of the easiest and widely accepted modes of indirect investing.
3. National Pension Scheme (NPS)
As the name suggests, this type of investment has a very specific goal. Each investment should have a purpose – retirement planning. We had discussed this is the article Investment – Basic Elements. You have to keep adding money to your NPS account regularly. On maturity, that is when you reach your retirement age, you can withdraw a certain amount of money from it, and transfer the rest in an annuity plan. Like mutual funds, fund managers handle the investments in this scheme. He invests a part of your investment in equity, based on your preference.
The government has laid down very strict guidelines for NPS. This is to ensure that the fund managers don’t take unnecessary risks with your retirement corpus. To safeguard the goal of retirement savings, the government also imposes a lot of restrictions on the withdrawals from this scheme. NPS also offers substantial tax benefits.
4. Insurance plans with an investment component
These are hybrid instruments that cover both life insurance and investment. They are like a mixture of insurance and mutual funds. The insurer invests a part of the premium you pay in the equity market. Another part goes towards your insurance cover. So these types of products cover your life and also provide an avenue for the money invested to grow.
But you need to understand that these products offer a much lesser life cover when compared to a pure insurance plan. Also, the returns are lower than comparable mutual funds as they have to balance both the benefits in one scheme. I would advise you to keep insurance and investment separate from each other. Better take a term life insurance to cover your life and choose any other method for your investments.
5. Portfolio Management Service (PMS)
It is a specialized investment vehicle for investors with funds above a certain level. Many financial firms provide this kind of service. The exact terms might vary from one firm to another. In PMS, you hand over your funds to an expert fund manager who then manages it on your behalf. Your money is not pooled with other investors’ money. It is different from mutual funds. In PMS you have more visibility and control over your investments.
Think of it as you have hired an experienced hand to look after your investments. He does all the buying and selling of equities on your behalf from your account. All the transactions and securities remain in your name. You have to pay a fee to the expert for his services.
6. Private equity
I briefly mentioned about investing in unlisted equity earlier in this article. There are ways to invest in private equity, although it is not as easy or popular, as the five other instruments we talked about above. You can purchase private equity shares from the owners of such shares like the promoters, investors, employees, outside of an exchange, or a formal platform. These would be individual transactions where you will have to find the right party who agrees to sell his equity shares at a reasonable price. These are specialized transactions and form a very small portion of the total retail investors’ transactions.
Conclusion
We have looked at some key ways to participate in the equity market. The most popular ways are direct equity and mutual funds. This was just a brief introduction to the different avenues available to you as a retail investor. This, by no means, is an exhaustive list. There could more advanced and innovative vehicles available today or tomorrow.
Keep exploring and stay invested!!!