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Jan 13, 2017

Debt & Equity, What Every Smart Investor Needs to Know

By Clare Edgerton

What’s equity exposure? Or a debt equity ratio? We break down the jargon.

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You may know that you can invest in debt and equity, but do you know what they mean for your investment future?

Let’s break it down.

Equity is ownership. Debt is a loan. 

Let’s start with equity.

We know equity is ownership. But ownership of what?

In the wonderful world of investing, ownership is most often called stocks or shares. The terms stocks and shares are often used interchangeably. If you own shares, you’re a shareholder (Go you!). And this means that you have ownership interest* in a particular company or industry.

*If “ownership interest” sounds a bit jargon-y, think of it this way: you own a portion of a company, so you’re interested in the growth and prosperity of that company.

If you’re a shareholder, you are investing in the future of a company. As stock values and share prices rise and fall, so do the value of your investments.

Another benefit of stocks is that some equity investments also pay dividends. Dividends are handy payments a company can issue when they generate profit and distribute a bit of that money to each shareholder in proportion to how much they have invested.

Now on to Debt

Debt is a loan. And it is a loan you are giving to a company. As an investor, this happens when you buy ‘debt instruments’ called bonds.

Here’s the Tl;dr, to get us on to the good stuff (aka, what this all means for you as an investor):

Sometimes a company, municipality, or government needs to raise funds, and they ask real people like you and me for money, in the form of issuing bonds. This means that you loan them a set amount of dough, and they agree to pay you back, plus interest, over a set period of time.

For most bonds, payments of interest happen at a predetermined rate and schedule, which is why they are also called fixed income securities. You know how much you’re going to get, and when. And when your bond matures*, you get back your original investment.

*Maturity of a bond does not guarantee any increased maturity of its owner.

Debt and Equity: Compare & Contrast

You now have the basics of debt and equity, know the difference between a stock and a bond, and can hold your own the next time you’re at that family reunion and your annoying hedge-fund-manager-cousin tries to impress the family with all their investing jargon.

But what does all of this mean for your investing future?

Exciting Equity

Equity has built in risk, but also has the potential for growth. In this case, the old adage is often true: The higher the risk, the higher the (potential) reward.

Some Stash investments with higher equity exposure include:

Delicious Dividends: As the name suggest, the companies represented in this fund have a history of showing investors the dividend dollars.

Roll With Buffett: This is the only fund on Stash that is not an ETF. When you Roll with Buffett, you’re investing in Berkshire Hathaway, Warren Buffett’s famously successful holding company.

Global Citizen: If you’d like to diversify your equity portfolio and invest in some companies not based in the United States, this fund represents companies that are almost equally split between the U.S. and beyond.

Dependable (Investment Grade) Debt

Investment grade debt can be pretty darn dependable. This is because when you invest in bonds issued by highly rated corporations and governments, they are keen on servicing their debt, which means making their payments on time.

There are a couple Stash investments with plenty of bond action:

Public Works: Those municipal bonds we mentioned earlier? Here’s where you can find them on Stash! Bonus: muni interest income is exempt from federal taxes.  

Uncle Sam: Here’s the Stash way to invest in treasury debt, which is considered pretty much risk-free.

What’s Your Equity Exposure?

Finally, we here at Stash think you should diversify that portfolio! And this means having some equity and some debt.

When investing, you want to have some exposure to a variety of investments. This can help to minimize your risk, while encouraging potential for growth. Only investing in (investment grade) debt: pretty darn conservative. Entire portfolio of equity: pretty dang risky. So instead, we suggest you find the balance that is right for you.

Another way to think about this is asset allocation. How are your assets invested?

Are you ready for some risk and want to invest more aggressively? Then go for the equity and consider grabbing some Aggressive Mix. Want something dependable with plenty of bonds? Conservative Mix might be your ideal investing cocktail.

Still not sure what you should be investing in? Well, a common adage is that your equity exposure (aka the amount of risk you are taking by investing in equity), should be higher when you’re young, and get lower as you get older and might want to move on to a more conservative investing approach.

When you’re young, and employed, and have decades of time to let that investment sit, you might take a bit more risk, and err more on side of more equity.

Written by

Clare Edgerton


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