What is the difference between debt and equity products?

by Manshu on February 13, 2011

in Investments

This is another post from the Suggest a Topic page, and this time we’re going to take a look at the difference between debt and equity products, and some examples of both.

Difference between Debt and Equity Products

Difference between Debt and Equity Products

What is equity?

Equity refers to part ownership in a company, and in the Indian context – equity and shares are used inter-changeably.

So, if OneMint were a company that had 100 shares in the market, and if you bought 1 share of OneMint – you would be the owner of 1% of OneMint.

If OneMint was valued at 1 lakh rupees today, then your share would be worth Rs. 1,000.

If 5 years from now – OneMint were valued at Rs. 10 lacs then your share would be worth Rs. 10,000.

If however, the company went bankrupt then your share would be worth nothing. Equity products are generally considered to be high risk – high return products for this reason.

Examples of equity products:

Shares: Shares trading on the stock exchange are the most direct examples of equity products.

Equity Mutual Funds: Mutual funds that own shares are another example of equity products. ELSS mutual funds that are eligible for 80C tax savings are a popular example of equity mutual funds.

Equity based ETFs: ETFs that are based on shares like Nifty Index Funds are also an example of equity products.

What is debt?

Debt is loan, and carries a fixed rate of interest, and a promise to repay. Debt is generally safer than equity, and there is generally no upside in it. You get paid the promised interest, and as long as the company (or country) is not bankrupt – you’re safe.

For example – OneMint could issue debt of Rs. 1 lac at an interest rate of 15% per annum, and as long as OneMint is not bankrupt – you can expect your interest repayment, and also the repayment of your principal.

If OneMint goes bankrupt, then first the shareholders are wiped out, which means that your shares in OneMint are worth nothing now, and then the debt is paid off according to the hierarchy of creditors.

A secured debt is debt that is secured against a collateral like a building, land, machinery etc. and they have a higher repayment priority than an unsecured debt, which is not secured against any collateral.

Examples of debt products:

Fixed Deposits with banks are the prime example of debt products. They are extremely safe investments, which have a pre-determined interest rate. The stock of SBI may have wild swings but your fixed deposit with SBI is safe, and won’t be affected till something really serious happens.

Infrastructure bonds that have recently been launched are another type of debt product as they pay you a fixed interest rate, and the principal is protected as well. They are not as safe as bank fixed deposits, but if any infrastructure company defaults on their debt – that would be an exception rather than the norm.

FMPs – These are a special type of mutual funds that have become popular in the past few years, and work like fixed deposits (though not as safe as them). They have become popular due to favorable tax treatment when compared with a fixed deposit,  so people don’t mind taking the little bit of extra risk.

POMIS: Post Office schemes are also debt schemes as they pay a fixed interest, and are also guaranteed. These are very safe instruments.

Provident Funds: This is also a debt product, which is quite safe and pays a fixed rate of interest.

These are some of the key things that come to my mind when explaining the difference between a debt and an equity product – feel free to add anything that I have missed, and as always – comments are welcome.

{ 48 comments… read them below or add one }

AML February 13, 2011 at 11:41 PM

I never got these two wrongly and i don’t see how one could get confused by these two terms, seems very elementary to me.

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Manshu February 14, 2011 at 4:46 AM

Everyone has to start somewhere and in the beginning you need some explanation for elementary terms as well.

I recently got a Macbook and have searched for a lot of basic stuff like where is the shut down button, how to get to the desktop etc. I’m glad others took the time out to post such things online else I would’ve been stuck and unable to perform simple operations which are obviously elementary for pros.

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Abhishek July 27, 2012 at 12:13 PM

Very nicely put sir!

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Manshu July 29, 2012 at 1:50 AM

Thanks

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Mohan R February 14, 2011 at 8:37 AM

Hi Manshu,

I would like to ask one thing. how post office generating income to pay interest for their schemes.

Regards
Mohan R

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Manshu February 14, 2011 at 8:50 AM

Good question Mohan – I actually don’t know about this. Will try to dig up the info though, and also a good topic to ask on the forum.

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Loney February 14, 2011 at 7:42 PM

Hi
All post office schemes are soverign in nature, meaning they are guaranteed by the Govt. of India. All the money paid to post-office schemes is utilized by the Govt. of India for various schemes (infrastructure, education, public welfare, etc.,) In other words, they work on the lines of GoI bonds. The GoI pays the interest. Post office schemes are the safest instruments in India and they are rated as Soverign.

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Manshu February 14, 2011 at 8:25 PM

Thanks Loney.

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Shilpa Gupta February 14, 2011 at 9:31 AM

Thanks Manshu. You explained it very nicely. Good Job again!

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Manshu February 14, 2011 at 9:56 AM

Thanks for your comment Shilpa – good to see that you found it useful.

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Vinay S Shastry February 15, 2011 at 1:05 PM

Hi,
You should mention about the insurance cover in FDs (up to Rs.1 lac per depositor per bank).
So, even if a bank fails (worst case), there is a high chance of getting back the money in FD.

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Manshu February 15, 2011 at 4:16 PM

That’s a good point Vinay – thanks for bringing it up. If a person splits their deposits across banks, are all the deposits covered with the insurance?

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Ramesh March 17, 2011 at 2:33 AM

yes both accounts are separately insured if both banks fail. alternatively you can have separate accounts for each of your family member or several joint accounts of more than one individual even if they are in the same branch as long as the order of their names appear in a different order say ABC, ACB, BAC, CBAetc. each would be separately insured for a balance upto 1 lakh!

please correct me if I am wrong.

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Manshu March 17, 2011 at 6:29 PM

Thanks Ramesh – your explanation sounds correct. Here is the link to the RBI guideline on this:

http://www.rbi.org.in/scripts/FAQView.aspx?Id=64

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satish jaitmal April 6, 2011 at 7:02 AM

Thanks for shearing the good things and best knowledge with me thatnks again for that .

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Manshu April 6, 2011 at 2:17 PM

You’re welcome Satish.

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Abdul Wahid Khan November 12, 2011 at 11:08 PM

Thanks Manshu for the valuable article. Its very nice 🙂

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Manshu November 13, 2011 at 8:37 PM

Great to hear – thanks!

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Raja Venugopal January 7, 2012 at 11:42 AM

Manshu Thanks for the information, especially very valuable points from Loney, Ramesh & Vinay

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Manshu January 9, 2012 at 3:11 AM

Thanks and appreciate your comment!

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bharathi February 26, 2012 at 12:30 AM

Thanks for the information Mr Manshu….it was explained well.

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bharathi February 26, 2012 at 12:32 AM

Great job Mr.Manshu…u explained it very well.Thank u:-)

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Sanket Jain March 23, 2012 at 4:27 PM

Thanks for this article. That was really helpful
I always had this phobia about these financial jargons, but this article explained things with subtle examples….

Thanks for sharing this wonderful piece of information in such a simple way 🙂

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Manshu March 24, 2012 at 11:26 PM

Excellent! Glad to hear that and thanks for your comment!

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raams April 19, 2012 at 10:15 PM

how can i create TPIN AND CPIN

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Manshu April 22, 2012 at 9:13 PM

What is this and why is it needed?

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Arun May 13, 2012 at 3:14 PM

These 2 terms always stumped me, till now I must admit this is the best and simple explanation of them. Thanks again

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Manshu May 13, 2012 at 5:55 PM

That’s great to hear – thank you!

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Deepak Kumar June 14, 2012 at 2:38 PM

Very good explanation. I was about to start a SIP and wanted to know the diff btwn Debt and Equity. You explained it very well…

Thanks.. 🙂

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Manshu June 15, 2012 at 5:05 AM

That’s great to hear – thanks! If you have any questions or anything, just leave a comment and I’m sure that either me or someone will answer that as well.

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bemoneyaware June 14, 2012 at 5:29 PM

Simple explanation for beginners but just wondering how would Debt mutual funds figure in?

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Manshu June 15, 2012 at 5:03 AM

Not sure if I understand the question, debt mutual funds will be a debt product, no?

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abhinav August 5, 2012 at 10:47 PM

Which is better equity or debt in the capital structure ?

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demat September 8, 2012 at 5:54 PM

THANKS.

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mukesh March 26, 2013 at 10:23 AM

first of all i’l like to say that post was awsmmmm..now cming to my doubts..what are SIP and SWP?also wud like to know what are the taxes implement on the debt mutual fund?as am a newcomer to whole of this am so eager to learn about all…waiting for answer thanks 🙂

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Manshu March 27, 2013 at 7:03 AM

Thank you Mukesh.

SIP is Systematic Investment Plan which means you invest a fixed amount every month. SWP is Systematic Withdrawal Plan which means you redeem some of your investments every month and thus earn a regular income.

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mukesh March 27, 2013 at 10:03 AM

thanks manshu,actually am about to invest a lumsum amt very sOon so am studying all about these funds n all..on the way whIle i was studying about stocks n all i also read about RD and FD am jus so shocked to see how govt make us fOol.In FD if your interest exceeds 10,000 annually there is a 10% TDS but on the other hand they say if your going for RD you will get everything as FD, (which is also not true) and there is no TDS now the point is whenever we get out amt after maturity period trust me if u deposited a lumsum in RD yoi will find yourself already in 30 or 40 bracket of slab …in FD u pay 10% TDS and then remaining 20% cut acc to slab and in RD you dnt have to pay TDS but 30% acc to slab also there is less interest in RD as compared to FD….manshu see i know thats aload to ask,but i found thIs blog pretty useful so jus waitin fo ur reply…. 🙂

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Manshu March 27, 2013 at 8:23 PM

I read your comment a few times but I’m not sure what the question is. Yes, you have to pay tax at 30% in both these cases, there is no way to avoid that if that’s what you are asking.

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mukesh March 27, 2013 at 10:08 AM

does SIP and SWP also be used in deposits like FD and RD?? I mean they say if you have a FD then there is a provision to get the interest on quaterly basis…not mnthly..so is there anythIng that can give me income monthly?

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Manshu March 27, 2013 at 8:21 PM

Not on a FD as far as I know.

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mukesh March 27, 2013 at 9:34 PM

yes you are right.i was asking about thOse two cases,we have to pay that 30%.Thanks manshu for replying my each query 🙂

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mukesh March 27, 2013 at 9:46 PM

hey manshu am back with anothr doubt….suppose if a senior citizen deposit 25lacs in an account and the bank has to pay 10% intrst on it for a year,now coz hes a senior he dsnt have to pay 10%TDS though his intrst will exceed 10,000.Also according to senior slab he dsnt have to pay incOme tax coz hIs annually incOme will 2.5lacs(if the FD intrst is the only income source)…now i have two qustns.First qustn is am i right with my statistics?and the second is …Does he has to pay income tax return?….ya i said that his annual income is 2.5lacs and according to slab he dsnt have to pay income tax return but does he has to pay return?…..manshu plzzzzzzz answr these two qustns as i badly need your response…thanks 🙂

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mukesh March 27, 2013 at 9:48 PM

i meant if a senior deppsit those 25lacs in FD..

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mukesh March 27, 2013 at 9:51 PM

if his annual income is 25lacs by FD source which is the only source of income for him and according to slab he dsnt have to pay income tax..does he has to pay income tax return?**** plz answer this manshu…

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a s pandey July 21, 2013 at 12:42 PM

very good explained

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Abhay Nagpal April 19, 2014 at 1:15 PM

Very clear and simple. Thanks.

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Ranjan June 26, 2014 at 5:32 AM

Fantastic mr Manshu…its very sumple after your explanations. Thanks

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Madhu March 28, 2015 at 5:29 PM

Best simple answer that anyone can get! Good work!

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