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Many a times we hear investors saying that they have investments in equity and mutual fund. Is this a correct statement? What is the difference between investing in equity market and investing in mutual fund? When someone says I have investment in equity and mutual fund it is like saying I am going to the plane and Delhi. Sounds weird isn’t it? How can some one go to plane? Plane is a vehicle, which can take us to Delhi, and Delhi is a city.

Somewhat similarly equity is an asset class while mutual fund is a vehicle, which helps us invest in a particular asset class. Through a mutual fund investor can invest in equity, debt or gold. To be a successful investor it is important to know the difference between asset class and investment vehicle.

Broadly there are two asset classes, financial assets and real or physical assets. Financial assets can be further divided into debt and equity. Similarly real or physical assets can be divided into real estate, bullion etc.

Financial Assets

Each of the assets has their own characteristics. When an investor invests in debt as an asset class he is playing a role of a lender. For example when we invest in bank fixed deposit we are lending money to bank. In return we earn interest. Debt based instruments have fixed maturity period. Upon maturity principal amount is given back to the investor. Usually debt as an asset class does not beat inflation. There is some exception to the concept of earning interest in case of mutual funds and traditional insurance policies like endowment, money-back and whole-life. In case of debt based mutual funds we earn in the form of dividend. Similarly in case of traditional insurance policies we earn in the form of bonuses. However debt mutual funds and traditional insurance polices earn by way of interest from its underlying instruments.

In case of equity, investor is playing a role of an owner – shared owner. When we purchase shares we share the ownership of the company. Returns from equity investing are in form of capital appreciation and dividend payouts. There is complete possibility of losing originally invested amount. In long run – over a period of 7 to 9 years - equity has potential to beat inflation as well as returns generated from debt. However in near term it could be highly volatile.

Real or Physical Assets

Real or physical assets are ones that an investor can look and feel. Real estate, bullion in form of gold, silver etc. are some of the examples. Here investor is complete owner of the asset class. His returns are mainly from capital appreciation. In case the investor has leased out real estate then there could be rental income from the investment.

Vehicles to invest in these assets

Financial wizards have developed various vehicles to invest in the above mentioned asset classes. Mutual fund is one such vehicle. Through mutual fund we can invest into debt, equity, gold and soon we will have real estate mutual funds. Similarly, investor can invest into insurance products. Traditional insurance products invest into debt. ULIP investment can be into debt or equity. It is important to note that currently in India expenses charged by investment oriented insurance products is extremely steep and hence they should “not” be used for investment. Portfolio management services could be another route to invest into debt, equity and even real estate.

Invariably it has been observed that investor intermingles asset class and investment vehicles. For example many a times investor says I have investment in equity and mutual fund. Similarly people treat fixed deposit and traditional insurance as separate asset class.

This kind of behavior proves detrimental while deciding overall asset allocation of one’s portfolio. While developing investment strategy first decide overall asset allocation based on asset classes. Having decided asset allocation choose investment vehicles which will optimise your returns from underlying asset classes.