Equity Shares: Definition, Advantages, and Disadvantages

Financial freedom is a crucial aspect of life as it helps individuals lead a comfortable retirement life, ensuring family security and stability. Wealth creation at a rate higher than inflation is important to achieve financial freedom. There are many investment options in today’s financial markets, but investing in equity shares is one of the most popular and effective ways of creating wealth. It offers investors the opportunity to earn substantial profits on their investments. At the same time, equity investments have their drawbacks that you should consider beforehand. 

In this blog, we will discuss equity shares. We will go through the definition, advantages and disadvantages of equity shares and their various types.

What are Equity Shares?

In the simplest terms, equity shares refer to partial ownership of a company. You buy some shares of a company from the stock market, which gives you a part shareholding in that firm. As the firm performs well, your investment automatically grows. Besides this, you get investment returns through dividends, too. In addition to this, you can also participate in important events like voting in annual general meetings.

You can buy or sell the stocks through the stock market exchange. To do this, you will require a trading account. Depending on the market behavior and recent performance, the investors choose the company to invest in and expect capital appreciation over their investment period. When the company you have invested in is performing well, its share prices rise, and you make a profit.

Read Also : Equity Mutual Funds: Meaning, Types & Features

Types of Equity Shares

Equity shares are primarily of two types, as given below:

1. Ordinary Shares: These are the most popular ones that offer shareholder voting rights. Additionally, they are eligible for dividends. At the same time, you should be aware of the fact that dividends are not guaranteed and can fluctuate depending on the performance of the company.

2. Preference Shares: Unlike ordinary shares, it offers a preferred dividend. It means preference shareholders get a fixed dividend before it is given to ordinary shareholders. However, they do not usually get voting rights.

However, there are some other types of shares that can be considered sub-types of ordinary shares. The sub-types of ordinary shares are mentioned below:

• Bonus Shares: Sometimes, companies may issue bonus shares instead of dividends. It is a strategic move where the company issues shares to reward the existing shareholders and reinvests the retained earnings back into the business.

• Rights Issue: A rights issue is when a company offers its ordinary shares to its existing shareholders at a discounted price. It helps the company raise capital while giving current holders the advantage of purchasing additional shares at a lower cost.

• Sweat Equity Shares: These are shares issued to employees or directors of a company as a reward for their hard work and commitment. It’s a way of compensating employees without immediately impacting the company’s cash reserves.

• Voting and Non-Voting Shares: As the name suggests, voting shares give shareholders the right to vote during important meetings and participate in decision-making processes. On the other hand, non-voting shares do not offer such rights.

Advantages of Equity Shares

Equity investments are a steady and smart way to create wealth and help you secure your future financially. If you begin investing at a young age or as soon as you start earning, it can do wonders in the long term. The advantages of equity shares are:

• Capital Appreciation: Considering the increasing cost of living and more ambitious lifestyle, having substantial capital with you becomes crucial. One of the most attractive features of equity shares is the potential for capital appreciation. As the company performs well, share prices go up, which results in investment growth. Thus, you can create good wealth over time without much stress.

• Dividend Income: Companies provide a portion of the profit to their shareholders in the form of dividends. However, it is not a guaranteed income, and the decision depends on the management. But, if you strategically invest in dividend-paying companies, it can give you some additional income.

• Liquidity: Equity shares of well-known companies with a good performance history are usually highly liquid. Unlike assets like gold or property, you can buy or sell them easily and quickly and can start with a small amount. It allows you to enter or exit the market at your convenience.

• Voting Rights: It is another advantage you get for investing in equity shares of a company. You can participate in important events like voting for the election of the board directors.

• Inflation Hedge: Over time, the value of money tends to decrease due to inflation. However, equities have the potential to grow your investments in value over the long term, often outpacing inflation. This makes equity shares an attractive option for those looking to preserve and grow their wealth.

• Diversification: Through equity share investment, you can invest your money across different companies and industries. It gives you a diversified portfolio and helps you protect your capital from any sector-specific risk.

Disadvantages of Equity Shares

We know the numerous benefits equity shares bring, but we should also consider the potential drawbacks. Investments in equities are subject to market risk; therefore, it is important to understand the nuances well and make a strategy beforehand. Here are some points that you should consider:

• Market Volatility: Share prices can fluctuate dramatically depending on market conditions. It is important to understand this aspect of equity investments before you make any investment.
• Risk of Capital Loss: It is one of the major disadvantages of equity shares. If the company you have invested in starts performing poorly, the stock price decreases, resulting in the loss of capital.
• Time-Consuming: Searching for a good investment opportunity requires time and hard work. Keeping an eye on important news (domestic or global) becomes important if you want to identify these opportunities.
• Limited Control: Although you can vote during important events, it usually doesn’t have much impact on the final decision.

Considering these factors, it is important that you gather significant knowledge about equity investments. Investors must learn about the business they are investing in and then make an informed investment decision.

Read Also: Types of Investment in the Stock Market

Why Should You Invest in Equity Shares?

Despite posing a risk of capital loss and other potential cons, equity share investment is still one of the most effective and lucrative ways of wealth creation. For young investors with a higher risk tolerance, equity investments are crucial to achieve financial freedom as early as possible. You can open a demat account online and start trading. Over time, compounding growth can lead to substantial returns.

Conclusion

Equity shares are a powerful investment tool, offering the potential for significant growth and a sense of ownership in the companies that drive the economy. It is important to secure your future financially, and the best way to ensure it is to start your investing journey early. Over time, you can accumulate substantial funds. With adequate knowledge and smart strategies, equity share investment can be a great way to grow your wealth.

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