Which is better?Equity or Debt

Equity represents ownership in the business. Hence equity owner takes all associated risk with the business. But equity owner also enjoys rights on the profit, so there is no upper limit of return. To know more about equity please check what is equity

Debt investment is a loan given to someone. If a loan is given to someone i.e. peer-to-peer loan etc, borrowed money comes back with interest which is decided during loan approval process. But debt doesn’t represent ownership in a business. There is a fixed limit of return i.e. predefined rate of interest. Debt is called outsider’s money. Debt lender has the highest priority on the profit and assets of company.

If the financing is done by a single entity or a lending source then it is called loan. If the financing is done by public , it is called Bond. Bond  is also a type of debt financing. If a company needs funding, it can issue either stock or borrow loan from other financial institution. In some cases company issue bonds to raise funds. Government also issues bond to raise funds for public projects.

Some misconception arises that debt investment can’t be lost. But it is not true. Bonds can be lost or peer to peer investments can be lost if the borrower defaults or gets bankrupt.

Let’s see the key difference between loan and debt

  • Debt is a low risk and low return investment. If you desire for high return, equity would be a good option but the risk associated with equity is also high.
  • Some of the debt investment also requires collateral. In case of default, the assets can be sold to recover the loss. It provides guarantee that the whole principal amount will not be lost in case of default like mortgage loan or a car loan.  But equity holders never get such collateral.
  • Equity holders enjoy the voting rights for key decisions of company but debt holder is like outsiders loan and no such rights exists.
  • Equity holders are eligible for residual assets in case of default or bankruptcy. But debt holders have highest priority on company’s assets in case of default and bankruptcy proceedings.
  • Equity holders get profit from capital growth, dividends and buyback offers. Apart from that equity holders may get discounted price on new shares. But the debt holder has only one way of return which is the interest on the capital.

In long term growth, equity market has outperformed the debt investements. But the question arises the “definition of long term” . A time period could be small for one person but another person may feel it very long. What is someone’s financial goal and how many years left to achieve the goal ? This defines individual’s long and short term goals. The younger you are, the higher chances to recover from equity losses. But equity market is subjected to market risk and difficult to predict.

Based on your risk appetite, decision should be taken to choose between equity and debt.

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