Why Is Equity A Must In One’s Portfolio?

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Why Is Equity A Must In One’s Portfolio?
Rutvij Bhutaiya - 17 February 2020
Global financial equities are worth trillions of dollars. More than Rs 8,000 crore worth of monthly SIPs exist. Yet, many investors do not know what is equity. The reason is that investment advisors or relationship managers never try to explain the basics of equity. They usually sell equity products based on returns, risks, and commissions, which is not the right approach.

Understanding equity

What is equity? As per sources, equity is referred to as shareholder’s equity. It represents the amount that could be returned to a shareholder of the company if all the assets were liquidated and the company’s debt was paid off. In layman’s terms, equity is the ownership of the company. Let me explain it with an example, Mohanlal, the owner of a famous sweet shop in Rajkot, Kalyan Sweets, wants to expand his business to nearby cities like Bhavnagar, Junagadh, Ahmedabad, and Surat. To raise money, (for various operations or business expansion or shop maintenance) he created a company ‘Famous Kalyan Sweets.’ He decided to raise money through a private issue. Now, what is a private issue or private equity? In layman’s terms, private issue means Mohanlal will give away his ownership by 10 per cent to interested investors of a ‘Famous Kalyan Sweets.’ Now comes the question, who are these investors?

Who are investors?

Investors are people who assume they would benefit when Kalyan Sweets would open shops in more cities. Initially, Mohanlal decided to raise Rs10,00,000 by giving away 10 per cent of Famous Kalyan Sweet’s ownership, which would get transferred to a person who buys shares of ‘Famous Kalyan Sweets. Let us assume 7 per cent was bought by Mr. Champak and 3 per cent was bought by Mr. Guru. Now, how would Mr. Champak and Mr. Guru benefit from holding Famous Kalyan Sweets shares? Suppose, Famous Kalyan Sweets makes a profit of Rs 10,000 every month, then, Champak will get 7 per cent and Guru will get 3 per cent of the profit earned.
In real-world, let us assume that you are a 10 per cent equity holder of Bajaj Auto, this means that you are a 10 per cent owner of Baja Auto. Unfortunately, many investment advisors and relationship managers sell equity products (Mutual Funds, Stocks and ULIPs) based on returns and increase and decrease in price. And hence, they fail to explain the simple concept of equity.

Price volatility

If you look at the volatility of monthly, quarterly and yearly prices, you can see that risk is high in equity. Volatility in prices is based on the available information regarding a particular stock. Going back to the earlier example, let us say that during festive seasons, Mohanlal’s business is at its peak, then it will result in a higher share price. On the other side, if news breaks out that one of his shops caught fire and it resulted in a loss, then that sudden information will result in a fall in the share price. Unfortunately, when the price goes down, we assume that we lost the money in the equity market or equity mutual funds. This does not, however, mean that we should not go for high-risk investments in our portfolio.

Why you should hold equity

There are several reasons why everyone should hold equity (based on risk appetite) in their portfolio, especially, if the investment horizon is long-term. In the near future, if everyone around you is exposed to higher risk by investing in equity, which often gives higher returns, then one cannot afford to take lesser risks. Risky investment situation is not created by you but by risk-taking investors. Equities are indeed risky, but if understood properly, equities can give one’s portfolio an edge. So, do not end up making decisions based on herd mentality, rather, consult a financial advisor, who would help you in creating a uniquely crafted portfolio that would explore alternate investment avenues for getting superlative returns.
The author is the investment advisor of Capital Quotient
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