Today, we live in the 21st century, where investment possibilities are endless. We are not limited to just fiat money, today’s investment opportunities come in all shapes and forms, from cryptocurrencies to equity or even mutual funds. Before picking an investment dimension, we need to understand the dimensions individually, including their pros, cons, risk factors, volatility, etc. Let us begin with cryptocurrencies.
What is a cryptocurrency?
A cryptocurrency is a decentralized, digitalized, and secure form of currency. It is based on a technology known as the blockchain and is considered the most important innovation of the modern world. You might have heard of the words – Bitcoin or Ethereum, these are just two of the 5000+ cryptocurrencies currently in circulation.
Now let’s address the question that how does cryptocurrency works? Unlike all other fiat currencies, cryptocurrencies are not regulated by any single authority which maintains their value, leading to their widespread popularity. But instead, this task is done over the internet on a network technology known as the blockchain. What is blockchain you ask? It works as a decentralized and open ledger that maintains a record of all the transactions being made on it. These transactions are recorded in so-called blocks and are then chained together when a block is filled up. Because of its decentralized nature, this ledger is present on every computer and device present on the network/blockchain, thus enabling them to cross-check or cross verify the transaction made and hence eradicating the possibility of an instance of a fraud/theft.
We might have heard of the word crypto mining, and crypto miners. They are nothing but systems on the network racing to solve a mathematical puzzle in order to verify the transactions. Once verified they are rewarded with a small award of cryptocurrency known as the mining fee. This whole process takes a fair amount of energy. These cryptocurrencies can be used to buy regular services, items, and goods. The world of crypto, even with its fast-spreading popularity is still relatively in its early stages as it has yet not become a form of mainstream acceptance. Others cryptocurrencies except Bitcoin and Ethereum are known as altcoins and millions of users trade as well as mine these cryptocurrencies daily. The volatility of cryptocurrencies is quite high as compared to traditional stock trading, but so are the returns. For example, if you had invested Rs.1000 in bitcoin back in 2010, you would have about Rs.128 Crore today in 2021. Yes, you read that right. 128 crores. But it is not always as merry as it sounds, cryptocurrencies are highly speculative and cannot be read or predicted accurately, thus increasing their volatility and risk factor.
What is a mutual fund?
Let’s move on to the next option of investment, and that is mutual funds. A mutual fund can be considered as a professionally managed investment fund that has multiple investors pool in their money and have it invested in multiple financial fields and instruments, such as stocks, bonds, and shares etc. Depending on what kind of investments are made, these funds start generating wealth over a period of time.
The “Professional Management” stated earlier is done by a fund manager, who has the relevant professional knowledge to make the investment decisions. The mutual funds in India are regulated by SEBI (Securities and Exchanges Board Of India). Mutual funds give small investors access to portfolios of bonds, equities, and other such securities in a professionally managed manner. The performance of a mutual fund is measured by the change in the total market cap of the fund. The value of the mutual fund firm depends a lot on the kind of securities it decides to buy. Now you may ask what’s the difference between a mutual fund and a stock? So unlike buying a stock, a mutual fund does not offer you voting rights (or stake) in the company, so a share in a mutual fund represents multiple investments in multiple securities/stocks instead of just one particular holding.
You might have heard of the word NAV, or what is that funds NAV? NAV stands for a funds net asset value, which is calculated by dividing the total accumulated security value by the total amount of outstanding shares. A mutual fund’s shares can be bought at its current NAV which unlike a stock’s price does not fluctuate when the market is open, thus bringing its volatility quite lower as compared to other investment branches. In simpler terms, a mutual fund is both a company holding as well as a share, so when an investor invests in a mutual fund he/she is buying partial ownership of that company as well as of all the assets that the company owns.
There are different types of funds such as Equity funds, Index funds, Income funds, Balanced funds, and many more upon which we’ll be shedding some light later on. Mutual funds are easily accessible, it brings up the major point of diversification of portfolios, and is professionally managed.
What is Equity?
Equity in its simplest form means “What is a company worth?”. In the world of finance, equity can be defined as assets that might have liabilities/debts attached to them. Equity in accounting is calculated by subtracting the liabilities from the assets, thus giving us the actual value. In other words, it means the amount of money that would be returned to a shareholder if all of its assets were liquidated, after getting rid of all the liabilities such as debts, etc. Whenever any companies financial standing and health is being considered, its equity is always taken into account.
One of the benefits of owning stocks or equity is the regular payment of dividend income. A dividend can basically be defined as the payment of some of a company’s earnings to the shareholders. There are some eligibility criteria to be met in order to get the dividends. Equity is used as the capital by many companies which in turn is used to acquire other assets, etc. It represents the value of a shareholder’s investment in the company, thus highlighting its importance. By owning equity investors now get the right to vote in contrast to mutual funds, on the actions taken by the board or the company as a whole.
Now, equity can be both positive as well as negative. When we look at the formula, the ways equity can be negative is when its liabilities/debts, etc. exceed its assets and vice versa. Some companies do not publically trade their stock, this is what private equity means. Even though there are plenty of other factors which go into analyzing a companies financial health, many still use the shareholder’s equity as a deciding factor to invest or not. The market value of equity is considered as the share prices product with the number of shares. This market value can be significantly lower or higher than the actual book value which is calculated by the formula stated earlier in the explanation.
How to choose?
In today’s world, there is no right or wrong option to invest into, as all three are subject to market risks. Some a bit more, the others a bit less. Crypto offers the high-risk high reward pathway, mutual funds on the other hand offer a steady capital growth (not an assurance, as it still is also market speculated) by portfolio diversification.
For a beginner, mutual funds are a good place to start followed by equity, given he/she has the right financial knowledge, whereas in the case of crypto if huge capital is in reach then the user can explore Bitcoin because of its value holding nature, whereas other altcoins can also be approached given the user understands the risks and its highly volatile nature. But overall as stated earlier, there is no right option, complemented with the right knowledge and experience, all three options can turn out to be a boon for the investor.