The value of money is increasing by the day and with this, the cost of living goes up too so the only way to continue living the lifestyle you’re accustomed to is by doubling your income. This is not easy to do though because when you’re a salaried employee, there is a fixed amount that you are paid every month and it may not increase by a substantial amount as the years go by, especially at a time of economic recession. In this day and age there are only two ways to make money – working for another person or investing your assets and letting them work for you. Since the value of money is increasing every day it is wise to do both because merely earning a fixed income is not enough and saving the money will only leave you with the amount you have earned. Investments are of many kinds, but one must tread carefully when choosing whether to invest in shares, mutual funds or debentures.
A mutual fund is a pool of money collected from various investors to invest in securities such as share markets, bonds, money markets and other assets.[i] Each mutual fund is managed by a professional money manager who allocates the fund’s assets and attempt to create capital or profit for the investors. A share in a mutual fund is not just one holding but a representation of many different stocks as the money manager uses his discretion to allocate the funds depending upon the predicted profit based on his professional experience. Since a mutual funds hold stock from multiple investments, the shareholders gain important diversification at low prices. For example, if A owns only Google stock and the value dips, he will lose a great amounts since all his money is tied to one company but if he had invested in a mutual fund which owned Google stock along with other assets, A would only lose a fraction of his money.
Investors earn from mutual funds in three ways:
1. From dividends (profits that the companies pay the stock shareholders)
2. From capital gain (difference between the amount invested and the current value of stocks in the market)
3. From selling mutual fund shares in the market (selling stocks that have increased in value for a profit)
Mutual Funds are categorized based on the securities they target and the type of returns they seek, example equity funds, fixed income funds, index funds, balances funds etc. Equity funds are the largest category and these funds typically invest in stocks of companies whether they are small, medium or large by using aggressive growth, income oriented or value-oriented approaches to investment. No matter the type of mutual fund, there are certain advantages that come with all of them like diversification, liquidity (ease of trading in stock), minimal investment requirements to buy various stocks, professional management by the money manager who will use expertise to invest wisely and freedom to choose from a variety of offerings depending on the manager and his management goals. There are also disadvantages like fluctuating returns, high costs for the money manager and cash drags in order to accommodate withdrawals and addition of money to maintain liquidity.
A share represents a unit of ownership of the company that you have invested in and the buying and selling of these shares happens in the share market.[ii] By buying shares, one is actually investing in a company so as the company grows so does the value of its shares. Selling the shares when they are high in value will most likely ensure the seller a profit. The National Stock Exchange and the Bombay Stock Exchange are the two main Indian stock markets, regulated by the Securities and Exchange Board of India (SEBI), where all the buying and selling of stock occur. There are two kinds of share markets – primary markets and secondary markets. A primary market is one where a company or the Government raises money for their growth, expansion and development by issuing shares through an Initial Public Offer (IPO). Through an IPO, the public can buy the shares and invest in the company by paying the fixed price (issuer fixes the price) or the book building price (price decided after assessing demand). A secondary market is a market where the shares bought in the primary market are sold either Over the Counter (informal markets where parties negotiate) or the Exchange Traded Markets (highly regulated markets where transactions take place through the Exchange). Investors in the share market earn money through:
- Capital Growth
- Buyback (company buys back its shares from the investors by paying a higher amount than the market value)
A debenture is a medium-term or long-term debt format that companies use to borrow money.[iii] Since they are loans taken out by companies or the government, investors of a debenture receive periodic interest, but it is never a huge amount. Both Governments and Companies use debentures to raise capital or funds the difference between the two is that with government debentures there is a security of a government issuer while with a company, only its creditworthiness and financial viability can be relied upon.[iv] Debentures can be of two types – convertible debentures and non-convertible debentures. Convertible debentures are those where the investors have an option of converting the debentures into equity if they feel that the company’s stock value is going to increase while non-convertible debentures do not provide this option to its investors. The advantages of a debenture are regular interest, convertible debentures and payment of debenture before stockholders in case of bankruptcy. There are disadvantages too and these are interest risk exposure is fixed-rate debentures, relying on creditworthiness of companies and inflationary risks of the coupons where the debt’s interest rate does not keep up with the rate of inflation.
Should a person invest in shares, mutual funds or debentures?
All three investment mechanisms involve multiple advantages as well as disadvantages. While Mutual Funds offer professional management and diversification, they come with the risk of relying solely on the money managers, so this means that there is a medium risk by investing in multiple assets with medium returns depending on how well each of the markets do. Shares on the other hand involve high risk because of investment in the shares of one company with high returns in case the values of the shares rise considerably. Debentures involve the lowest risk because of the fixed and reliable interest but this means that there will be low returns.
In conclusion, the type of investment depends on the person investing, the type of lifestyle they lead and the returns they expect. A young individual trying their hand at investments would prefer investing in a mutual fund where there is professional management and diversification while an older person who wants a steady income would rather invest in debentures. A fairly middle-aged individual with a little experience in trading stocks would prefer investing in the share market with a chance at high returns.
Edited by Pragash Boopal
Approved & Published – Sakshi Raje
[i]Adam Hayes, Mutual Fund, Investopedia, (September 4, 2019, 8:50 PM), https://www.investopedia.com/terms/m/mutualfund.asp.
[ii]What is Share Market, KarvyOnline, (September 4, 2019, 9:14 PM), https://www.karvyonline.com/knowledge-center/beginner/share-market/what-is-share-market.
[iii]What is a debenture?, Reviso, (September 4, 2019, 9:27 PM), https://www.reviso.com/accountingsoftware/accounting-words/debenture.
[iv]James Chen, Debenture, Investopedia (Septemeber 4, 2019, 9:39), https://www.investopedia.com/terms/d/debenture.asp.