- What are equities?
- Benefits of equity investments
- Equities and dividends
- What are preferred stocks?
- Getting equity through your job
Equities are the same as stocks, which are shares in a company. That means if you buy stocks, you’re buying equities. You may also get “equity” when you join a new company as an employee. That means you’re a partial owner of shares in your company.
Because equities don’t pay a fixed interest rate, they don’t offer guaranteed income. In other words, equities inherently come with risk.
What are equities?
The term equity has a different definition, depending on the context. When talking about the stock market, equities are simply shares in the ownership of a company. So when a company offers equities, it’s selling partial ownership in the company. On the other hand, when a company issues bonds, it’s taking loans from buyers.
People invest in equities because of their potential for high returns. In your investment portfolio, your “equity exposure” is another way of describing your exposure to the risk that you will lose money if the value of your stocks declines.
Conventional wisdom states that young people can afford more equity exposure and will likely want more stocks because of their potential for sizable returns over time. As you near retirement, equity exposure becomes more of a risk. That’s why many people transition at least part of their investments from stocks to bonds as they age.
Benefits of equity investments
As with any investment, equities offer several benefits that cause investors to want to put money into the asset. From the accessibility of equities to the high reward potential, there are plenty of reasons investors like equities to be a part of their portfolios. Here are some of the main benefits investors seek when investing.
- Reward Potential: For a limited investment amount, you can get access to a huge potential payout if a business grows exponentially in value.
- Dividend Payments: Some equities payout dividends from capital gains, which are payments from the profits the business makes to shareholders. This provides income while the overall value of the business is increasing.
- Diversification: You can invest in many equities from multiple industries to diversify your portfolio through mutual funds, ETFs or index funds.
- Accessibility: Because equities can be invested in through so many different channels, these investments and the benefits that come with them are extremely easy to access.
While equities offer some strong benefits, these investments are right for every portfolio. Investing with the right strategy in mind is important so that equities help you achieve your financial goals. Working with a financial advisor can be your best bet at creating that strategy or a financial plan to help you do just that.
Equities and dividends
If you own equities, the value of your holdings increases when the shares you own become worth more than what you paid for them. But owning equities is not the only way to come out on top.
For example, companies pay dividends out of their own profits and into the pockets of their shareholders. These periodic payments aren’t guaranteed, but they can provide major benefits when available. You can either reinvest your dividends or take them as income as an investor.
If you own equities, it’s important to understand the difference between capital gains and dividends. A capital gain is a difference between the price you buy shares and the price you sell them. There are long- and short-term capital gains, each with its own tax rate.
Dividends are taxed like long-term capital gains, as long as they’re “qualified dividends.” If you own equities, your broker or fund company should provide you with IRS Form 1099-DIV that breaks down your dividends and capital gains for the tax year.
What are preferred stocks?
Owners of preferred stock get more access to earnings and assets than “common stock” owners can claim. Preferred shareholders are more likely to get regular dividend payments (usually at a fixed rate) and get paid before the owners of common shares. The catch is that, because dividend rates for preferred shareholders are generally fixed, the owners of preferred stock won’t see their dividends jump as the company becomes more profitable.
If the company is bankrupt or liquidated, preferred shareholders have dibs on assets and earnings before common shareholders. Bondholders are at the top in the hierarchy of who gets to take a company’s assets if it folds, since they’ve loaned money to the company. Preferred shareholders are next, followed by common shareholders.
Getting equity through your job
Say you get a job offer with salary, health insurance, a 401(k) and equity. What exactly does “equity” mean in that case? It means you either have an ownership share in your new company now, or you will have one when your equity “vests”. In other words, when it becomes official by virtue of the fact that you’re still with the company. In some cases, your equity is given to you outright. At other times, it consists of the option to buy the stock at a preferential price.
Equity alone does not a great job offer make, however. Your equity won’t pad your bank account unless your company goes public or is sold (known as “exit events”). Plus, since your salary is already tied to the company’s fate, the more company stock you own, the more financial eggs you put in that basket.
When you invest in equities, it’s important to understand the risk you’re taking on. It’s also a good idea to fight against your natural biases.
Most people’s instinct is to buy stocks when they’ve already risen in value, which is called “buying high.” Then, during a stock market downturn, people panic and sell their shares, referred to as “selling low.” But to be successful in the equities market, you’ll need to do the opposite of what feels right, which often means buying low and selling high.