In current economic conditions, whom do you think is smarter? Debt or Equity?

Investing in equity gives us higher return and help us build wealth. But this is the sole reason for equity to be smarter than debt. On the other hand, debt has many reasons with evidence to be smarter than equity.

A stock market is always an emotional place where the equity price is driven by investor sentiments and, sometimes, fake news. All these may create greater volatility or ‘noise’ in the market. Meanwhile debt market runs on facts and figures, with economic trends holding the reins of prices. Any monetary policy changes bring rapid price movements in the debt market, while those changes may never impact the equity market.

If we consider market size, the debt market wins over the equity market. According to the data published by the Securities Industry and Financial Market Association, the international bond market was worth $128.9 trillion at the end of 2021, while the market capitalization of the global equity market stood at $124.4 trillion.

Opportunity cost is a significant factor that comes between equity and debt investing. Bond yields are the key to calculating the opportunity cost of equity investing. If the bond yields go up, the opportunity cost of equity investing increases, making equity less attractive for investing.

When bond yield increases, corporates have to pay higher interest on the debt. So as the cost of servicing debt increases, the risk of default and bankruptcy also increases.

It is undeniable that most financial scams in recorded history have been associated with the debt market. As a result, it prompts policymakers to take caution while making economic policies.

You must pay the risk premium to get a higher return from equity investments. But you can earn a decent return without taking much risk in the debt market. So, owing to their contrary natures, both asset class has significance in any investment portfolio. In other words, debt and equity are inevitable assets in our wealth creation journey.

Happy Investing!!

Neeru Seal

Alpha Research Team