Today we are going to cover a few aspects as to why equity is more risky than debt. From first impression to an individual that knows very little about the financial terms, this might seem crazy. Nonetheless, we are going to share you the details that makes debt essentially better than equity.
To help you better understand both terms, we define equity as the net amount (positive or negative) of funds invested in a business plus any earnings that were generated due to that investment. Debt, which is a bit more easily understood is simply an amount owed.
Equity Costs More Than Debt
As ironic as this may sounds, one of the main reasons why equity is more risky than debt is because it costs more than its counterpart. Debt is typically a specific amount that you have either spent or lost and the only way that your debt increases is if there is interest, fees, or penalites that is levied upon it.
However, equity represents the worth of an object (be it tangible or intangible) and has the ability to fluctuate according to factors that also may or may not be tangible. Once you payback both your interest and the amount of a debt, then typically your equity is what remains - the value of the property that has been paid for. If your debt and interest exceed the value of your property, then equity disappears altogether.
Debt can be written off on your taxes...equity cannot
Although debt does not sound like the most ideal situation to be in, in all reality, when it comes to taxes, you would want bad debt over bad equity. Every year (usually during the beginning of each year) everyone (including businesses) have to address the IRS and income taxes. Sometimes taxes are great for individuals as they can receive money back. However, for others the complete opposite happens (including receiving no money or actually having to pay).
With this in mind, your debt interest (that you pay off) can be written off on your taxes. For some people this does help reduce their tax burden and round out the numbers in a good way. For equity...that extra cushion is not there and you can not write-off equity interest on your taxes.
Debt essentially teaches you financial lessons that equity does not (respectively). With debt you understand the basic fundamentals of budgeting. Learning that if you are going to spend money you don't have, it is important to know that you can actually pay it back (plus interest). With equity, you simply learn how to earn and unfortunately lose money (only to gain it back if possible).
Consulting tax experts is probably going to lead to more clarity than we are able to provide when understanding why equity is more risky than debt, however, the summation is that debt is more controllable than equity and therefore a more reliable way for you to reduce the risks involved in making investments.
South Dakota paystubs provided this article free of charge. With no software to download, no templates to fill in, and no calculations to perform, say "yes" to your instant South Dakota pay stub for income verification!
This business is owned and operated by a U.S. veteran. The protection of your information is our TOP priority.