Wednesday, November 22, 2017
Lock, Stock, and Barrell – Equities Explained
Do you remember when interest rates were hovering around 10%? How about in the mid 1980’s when they were even as high as 18%? Well I don’t, but those must have been some magical times for investors. Not so much for borrowers. These days we are lucky to get 3% on our fixed income investments. They say you must have exposure to the Equities Market to get any sort of growth these days. The question is: What the heck is an equity? Is it a stock? A bond? Where is this Market you speak of? This week has been about explaining exactly what investments are all about so you can know exactly what you are invested in. Today we will tackle the equity market and show you the benefits and downsides of equity investing. Using equities in your investments portfolio can be very rewarding, but it does come with some risk so make sure you have all the information you need before jumping into the waters.
Definition: Equity Investment
Money that is invested in a firm by its owner(s) or holder(s) of common stock (ordinary shares) but which is not returned in the normal course of the business. Investors recover it only when they sell their shareholdings to other investors, or when the assets of the firm are liquidated, and proceeds distributed among them after satisfying the firm’s obligations. Also called equity contribution.
To break it down in understandable terms, investing in equities is investing in stocks. Stocks are dispersed by companies to raise revenue. A company like Apple sells pieces of its companies to investors so it can raise money to expand its business and grow revenue. By buying a share of a company like Apple or Facebook you are helping them raise capital in their hopes to make even more money. You want this to happen as then your stocks are worth more and you made some money. You only make money is you sell however, so don’t put the cart before the horse.
So, who cares?
Here is why you should care: Investing in equities has the potential to grow your money tremendously. Having even a little hand in the stock market can be a great source of interest that can compound over many years. It is also important to understand that in this age of low interest rates, to get some growth, you might have to venture into the equity markets. This should be done with knowledge and comfort and not with ignorance and fear.
Some Advantages of Equity Investing are:
- Dividends – A company will issue you a payout in the form of periodic dividends. These are given to shareholders as a “reward” for their investment. Not all companies give out dividends, but the ones that do are usually top-quality companies that have a focus on consistent growth.
- Liquidity – For the most part, equities are liquid. That means you can get rid of them easily at any time. This is important because you may not want to be locked into an investment for a long duration like you would be with some guaranteed investments.
- Diversification – You can structure your portfolio to have various types of investments, (fixed income: low risk, equities: higher risk). You can also structure your equity portion to have a well-diversified balance of sectors and regions. This means you can own stocks from many different industries and many different countries so that you are never too heavily vested in one area.
Some Negatives to Equity Investing are:
- Risk – There can be high risk with equity investing. Shares can go up and down at alarming speed. It is important to know this can happen and to prepare for the worst. This is where diversification comes in as you don’t want all your money in one company, fund, region or sector.
- Confusion – it can be hard to keep track of all the inner workings of any given company. Therefore, I always recommend using funds instead of buying direct shares of a company. I like funds because it gives me a small piece of great companies, without being too heavily weighted in them. One mutual fund can hold 100 different companies as opposed to having all my money in one or a few stocks.
- Dividends – While dividends can be positive, there can also be drawbacks to dividend bearing stocks. One of them is that companies that produce dividends take those dividends out of the profits and this obviously means that the stock is worth a little less because they gave out the dividend. It is also important to know that no company has to give out dividends, so they may suspend their payouts from time to time if they need the capital elsewhere. When a company suspends its dividends, it is not a good sign to the public and that could result in the stock being worth a little or a lot less.
Mutual Funds and Exchange Traded Funds (ETF’s)
Many people have their money in these two forms of equity investing. They give you exposure to the equity markets without being too heavily invested with one single company. Let’s define these two types of investments.
A mutual fund is an investment vehicle made up of a pool of money collected from many investors for investing in securities such as stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s investments and attempt to produce capital gains and/or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.
Exchange Traded Funds (ETF’s) also known as Index Funds:
An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. These funds adhere to specific rules or standards (e.g. efficient tax management or reducing tracking errors) that stay in place no matter the state of the markets.
Where I stand
I think exposure to the equity markets is important especially for younger investors. Younger people have the time to recoup any periodic losses that might occur during market downturns. The key for them is consistent contributions and patience. For older investors, some exposure to the equity market is alright, but it must be taken into consideration what your time horizon is and if you plan on withdrawing these funds anytime soon. As with all investing, knowing the investor is important. You have to your know net worth, liquidity, time horizon and most importantly, risk tolerance before buying equities. Despite the drawbacks, equity investing is a great way to grow your money, if it is done with proper care and consideration.
Thanks for tuning in today as Market Week continues at Budget Boss. Tune in tomorrow as we discuss Mutual Funds versus ETF’s, the age-old debate. If you would like to get started investing or would like a review of your portfolio, please send me a message at firstname.lastname@example.org. Have a great day friends!
“The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.” – Warren Buffet
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