INVESTING IN EQUITIES: Benefits and Simple Guide to Investing

Investing in Equities

As a beginner investor, one of the most essential and challenging decisions you will have to make is whether to invest in equity funds or individual stocks.
Investing in equities entails purchasing shares of a portfolio managed by a professional portfolio manager, who is in charge of selecting the stocks in the portfolio as well as making the buy, sell, and hold decisions.

What are Equities?

Equities, commonly known as “stocks,” are portions of a firm. When you acquire stocks or shares in a corporation, you are essentially purchasing a stake in that company. The stockholders or shareholders of a company all have equity in the company. They also possess a fractional portion of the company. They purchase the stocks with the expectation of profiting when the company profits. Companies issue two types of stock: common stock and preferred stock.

The Fundamentals of Equities

Depending on the context, the term equity has a distinct meaning. When it comes to the stock market, equities are essentially shares of a company’s ownership. When a company sells equities, it is selling a portion of its ownership in the company. So, when a firm issues bonds, on the other hand, it is borrowing money from buyers.

People invest in equities because they have the potential for high returns. Your “equity exposure” in your investment portfolio is another way of characterizing your exposure to the risk of losing money if the value of the stocks you hold falls.

According to conventional opinion, young individuals can afford more equity exposure and, as a result, will demand more stocks because of their potential for large returns over time. However, as you approach retirement, equity exposure becomes a greater risk. As a result, as they get older, many people shift at least some of their investments from stocks to bonds.

What are Common Shares?

Common shares can be issued by both public and private corporations. A company’s common shareholders are the owners who provide the first equity capital to launch the business.

Investors can get numerous benefits from owning common stock in a public corporation. Some of its primary advantages are as follows:

  • Capital augmentation
  • Dividends
  • Electoral rights
  • Marketability refers to the ease with which shares can be bought or sold.

There are a few disadvantages to owning common stock. Common shareholders, despite being a part-owner of the company, are in a comparatively weak position because senior creditors, bondholders, and preferred shareholders all have prior claims on a company’s revenues and assets. While bondholders’ interest payments are guaranteed, dividends are paid to shareholders at the discretion of a company’s board of directors.

What are Preferred Shares?

Preferred stock is a type of share capital that normally entitles shareholders to fixed dividends before common stock and a stated cash value per share in the case of liquidation. The preferred shareholder typically sits between the creditors and common shareholders of a corporation. If a company’s ability to pay interest and dividends is jeopardized as a result of bad earnings, preferred shareholders are better protected than common shareholders but worse off than creditors.

Preferred shares come in a variety of forms, including convertible, retractable, and variable-rate preferred shares. Most Canadian preferred shares are cumulative, which means that when dividends are withheld, they accumulate in arrears. Before any common dividends can be distributed, all arrears of cumulative preferred dividends must be paid.

Because preferred shares include both debt and equity characteristics, they serve as a bridge between the bond and common equity components of a portfolio. Because preferred shares are offered in such a wide range of options, they are ideal investments for the majority of investment portfolios.

One disadvantage of preferred stock is that many of them are non-voting. However, voting rights are normally provided to preferred shareholders when a certain number of preferred dividends are delayed.

Why Is Investing in Equities Important?

Whatever stage of life you are in, equities play a vital role in a well-diversified portfolio. They can assist you in increasing your savings, increasing your income, and protecting your wealth:

#1. Increasing your savings

Historically, equities outperform cash and fixed-income investments in terms of long-term returns. However, the value of equities tends to vary more. Because this volatility tends to flatten out over time, it’s vital to keep a long-term view while investing in inequities. Just because equity is down in one year does not guarantee it will be down in ten years. The goal is to distinguish between a momentary setback and a more significant one.

#2. Increasing your earnings

If you’re an income investor, you undoubtedly have a lot of T-bills and government bonds in your portfolio. However, it is critical not to forget the crucial function that equities can play in your portfolio. To begin, certain equities, such as income trusts, can boost your income. Furthermore, income from equity investments, such as dividends or capital gains, is taxed more favorably than interest income. Setting aside a portion of your portfolio for equities can increase your after-tax income.

#3. Keeping your cash safe

Another incentive to invest in equities is to safeguard your assets. This may appear contradictory considering that equity investments are not guaranteed, whereas fixed-income investments are. However, because fixed-income investments pay such low-interest rates, they provide no protection against taxation and inflation, which can erode your wealth over time. Again, adding a set amount of equities to your portfolio while maintaining the rest in guaranteed investments can help protect the value of your portfolio in the long run.

Equity Fund
Image Credit: Since Independence

How Do You Get Started Investing in Equities?

Investing money or capital is a significant decision in anyone’s life. As a result, it should be approached with caution and forethought.

The main point of investing money is to build an additional source of income as well as a substantial amount of wealth for your future that grows and appreciates in value over time. As a result, it is critical to comprehend the initial phases of this difficult yet rewarding path.

#1. Recognize your investor personality.

Repeat after me: “What kind of investor am I?” “How much risk am I ready to take?” “How much funds do I want to allot?” Answering these questions will help you decide what type of investments to make and, more importantly, will help you envisage your long-term wealth goals.

#2. Use technology to your advantage.

With technology scaling mammoth heights of invention in the fintech sector, there are a plethora of possibilities for seeking investment advice.

Robo-advisor services use machine learning techniques and algorithms to assist investors in making the best investment decisions. Combine this with other money management applications to keep track of your monthly investments, costs, and more. Using artificial intelligence in conjunction with human input will undoubtedly help to improve your financial portfolio.

#3. Choose blue-chips.

Blue-chip firms, which have a higher market capitalization and are more stable than others, are among the most highly appreciated in the market; they are financially stable and well-established. For newcomers to the stock market, investing in such companies is a safe decision due to the lower risk element associated with such companies.

Five Fundamental Rules to Follow When Investing in Equities

Some fundamental rules to follow when investing in the equities market include:

#1. Being disciplined and having a plan.

Although this may sound like life coaching advice, it is also applicable in the world of finance. Diving headfirst into the equity market without a plan is financial suicide and should be avoided at all costs.

If you are a first-time investor, you should develop a plan that focuses on your short and long-term financial objectives. Once this is in place, you may develop an investment strategy that is tailored to your specific needs and objectives. Furthermore, investing requires discipline in other aspects of your financial life, such as monthly saves. As a result, don’t forget to set aside your specified monthly savings and stick to your spending limitations as much as possible.

#2. Maintain a record of your investments.

Some people may be content with making an investment and then completely forgetting about it. However, as a rookie investor, it is critical to monitor the performance of your investments.

It is critical to rebalance and shuffle your portfolio as needed based on the performance of the funds. It is also critical to keep up with financial news and schemes so that you can utilize them appropriately. There is no shame in seeking the advice of a financial expert if necessary.

#3. Avoid herd mentality and do not follow that “tip.”

When it comes to buying and selling, there is always the temptation for a first-time investor to take the safe route and rally behind other investors. You might even be tempted to act on hot stock and fund advice from friends or coworkers. However, falling victim to such conduct is not sensible because it may result in damage to your financial portfolio.

It is recommended that you perform your own research and learn everything you can about how the equity market works. Keep up with the pink papers and all the current news in them, and don’t be afraid to combine this with the assistance of a financial advisor.

#4. Diversify your investments at all times.

When it comes to investing, the old adage “don’t put all your eggs in one basket” is really true. This is one of the most difficult guidelines to follow because it is human nature to keep re-investing more money into stocks and mutual funds that have previously performed well for you. We do this because of previous favorable experiences and to prevent risk.

However, the financial world is continuously changing, and what was a smart investment yesterday may no longer be a good one today. As a result, it is critical to investigate fresh and more profitable investment opportunities in order to maintain your portfolio current and expanding.

#5. Long-term thinking is the greatest strategy.

When it comes to investing, making a quick buck is not the best strategy. It is tempting to think of generating quick and easy money with stock market investments, but if you truly want your money to grow for your future, long-term investments are the way to go. When you focus on creating profits in the next 5-10 years, you give your investments a better opportunity of producing bigger returns. A long-term perspective also keeps you from making rash decisions based on market volatility.

Guide to Investing in Equities

If you determine that equity funds are the way to go, you’ll be faced with a new problem: which one? Because of the diversification provided by equity funds, you have a plethora of options depending on the types of firms in which the fund invests.

Equity funds are frequently constructed around the following themes:

  • Where to find the companies: Index equity funds invest in firms that are part of a specific index, such as the Dow Jones Industrial Average or the S&P 500. These enable investors to profit from broad market gains.
  • What the firms do: Investing in a certain industry, such as insurance, pharmaceuticals, oil and gas, or technology, provides greater variety than purchasing stock in a few companies in a sector.
  • Company size: Some equity funds focus on the size of a company, or its market capitalization, ranging from large-cap corporations like Apple and Disney to small-cap enterprises that may not be popular names but can create healthy returns.
  • Location: International or global funds invest in firms and industries all around the world, allowing investors to balance drops in one market with gains in another.
Read Also: Stockholder Equity: How To Calculate Stockholders’ Equity

Depending on the individual investor’s retirement goals, many investors design a portfolio with a mix of broad market funds and a few industries or geographically niche funds.

And where can you get them? There are three methods for purchasing equity funds:

  • Employer-sponsored retirement accounts, such as a 401(k) or 403(b) (b). Your choice of funds will be determined by the provider chosen by your company, but many plans offer a half dozen or so possibilities.
  • Directly through a fund provider like as Vanguard or Fidelity Investments, albeit your options may be limited.
  • By establishing a brokerage account. You’ll have more options if you’re not tied to a single fund provider. There may be an initial minimum deposit requirement, although some offer a $0 minimum to invest through an individual retirement account, such as a traditional or Roth IRA, or if you set up automatic monthly deposits. Costs and possibilities might vary greatly, so shop around.

Wherever you invest, keep an eye out for costs, which can eat into your gains over time. It is also important to consider how the money is administered. Some equity funds are actively managed, which means they strive to outperform the market. They do, however, come at a premium price. Others are passively managed, which means they strive to replicate market performance; they offer cheaper fees and, in many cases, higher returns.

Tips for Investing in Equities

Whether you’re new to investing or want to improve your current portfolio, the services of a financial advisor could be beneficial. Financial advisors can examine your entire financial status and conduct the necessary research to create the best investments for you.

More than simply equities should be included in a well-rounded investment portfolio. Consider diversifying your holdings by purchasing bonds, options, mutual funds, exchange-traded funds (ETFs), and other products.

The Advantages of Investing in Equities

Now that you understand what equities are and how to invest in them, let’s look at the different advantages that equity investment provides. Among the potential advantages are:

#1. Returns that outperform inflation

Inflation reduces the purchasing power of money over time. Long-term goals such as children’s education and retirement require you to invest in an asset class that has the potential to outperform inflation. Investing in equities can help you do so since they can generate long-term profits that outperform inflation.

#2. Growth of Capital

Investing in equities can significantly increase the value of your principal capital. If you invest an equity share in a fundamentally good company, the price will almost certainly rise over time. This capital appreciation can benefit you.

Those who remained loyal to their equity investments when markets plummeted in March 2020 are now reaping exceptional gains as markets have climbed over the $50,000 threshold. In addition, if a corporation releases dividends, it might supplement your normal income.

Risks Associated with Investing in Equities

Investing in equities comes with risks and is inherently volatile. Their prices are determined by a variety of internal and external factors, the majority of which are outside the control of ordinary investors. Price swings might be significant, and you must remain patient in such a case. In addition, when investing, you must take a long-term perspective. In the long run, the magnitude of volatility is greatly reduced.
You should not approach equity investment with a short-term mindset because it will almost always result in losses. A long-term view, along with discipline and patience, can assist you in leveraging the potential of equities to increase your wealth.

Other types of risk that can have an impact on equity investments are:

  • Credit risk: a company’s inability to pay its debts.
  • Foreign currency risk: the worth of a corporation may fluctuate due to changes in the value of several international currencies.
  • A company’s liquidity risk is that it will be unable to satisfy its short-term loan obligations.
  • Political risk: a company’s returns may suffer as a result of political changes or instability in a country.
  • Economic concentration risk: a company’s value may fall if it is overly concentrated in a single entity, sector, or country (putting all its eggs in one basket). If that factor’s value falls, the company will suffer disproportionately.
  • Inflation risk: a company’s value may fall as a result of growing inflation, diluting its worth.

Investing in Individual Stocks vs. Investing in Equities

Once you’ve found a decent equity fund, it’s up to you to keep buying shares, reinvesting dividends and capital gains, and reviewing the mutual fund’s annual report each year. Your goal is to guarantee that the management business adheres to the financial philosophy in which you believe and that you continue to be satisfied with the holdings. In many ways, it’s similar to evaluating the effectiveness of a building manager you engage to oversee your rental properties.

Picking individual stocks, on the other hand, means that it is your obligation to develop a portfolio, read annual reports and 10k filings, make purchasing and selling decisions, and stay current on what is going on at each of the firms in which you have an investment. After all, it is your hard-earned money. That sounds like intellectual torture to a lot of folks.

When constructing your own portfolio, you should be aware of your personal risk tolerance, existing budget, and long-term and short-term investing objectives.

Here are a few indicators that you should invest in equity funds rather than individual common stocks.

What distinguishes equity funds from stocks?

Individual business stocks and equity funds, often known as stock funds, are both ways to invest in publicly traded firms, and the appeal of both can be summed up in one word: growth. Buying and keeping stocks or stock funds over time is an important part of investing for retirement.

Many financial planners advise people to invest more money in equities early in life, then gradually change the components of their portfolio mix toward safer investments like bonds and money market accounts as retirement approaches.

Why? Individual company and index growth is a roller coaster ride. The younger the investor, the more time he or she has to ride out market downturns.

Equity funds aid in the smoothing of the ride. They are not immune to market fluctuations. In reality, if the mutual fund is doing its job well, its value should track the market’s ups and downs. A fund, on the other hand, comes with built-in diversification: You are distributing your investments among a number of firms, a sector, or the entire market. If one of the fund’s companies falls, superior performance by others can cover the loss, and your portfolio can still rise.

That’s a much safer bet for your money than relying on the performance of a single company. Direct ownership of a company’s shares has the potential to outperform the market, but it also entails a higher risk.

Financial Statement Analysis

Can you read GAAP financial statements, such as income and balance sheets? If you have that aptitude, picking your own individual stocks shouldn’t be much more difficult than studying a private business possibility like investing in a limited liability corporation (LLC).

In such a case, hiring a professional money manager to sit around all day researching firms for you seems a little ridiculous, unless you would rather focus on your primary vocation.

Examining Businesses

There are few things more pleasurable for some people than discovering a fantastic firm and learning about its business, industry, goods, cost inputs, and strategy, as well as how it fits into the globe.

Do you enjoy walking into a liquor store and knowing the gross profit margins for the company that distills a certain brand of whiskey? Do you like being able to walk by a hotel and know the average cost per room to build it? What about discussing the overall pre-tax profit it should generate assuming the company is run well and fairly successful? Studying businesses (and, by extension, individual stocks) is a method to gain a better understanding of the world and what people genuinely value.

If you don’t care about those things, it’s not worth your effort to look for particular companies in which you can become a partial owner. Instead, pay a professional’s management fee and invest in solid, well-diversified equity funds.

Equity funds can be actively managed, which means the portfolio manager employs their own judgment, or passively managed, which means the fund tracks a market index. Fees for passively managed funds are often cheaper than those for actively managed funds.

Which is better for me: Investing in Equities or Stocks?

If you can’t think like a long-term investor, you might want to add a layer of protection by investing in equity funds rather than individual stocks. Mutual funds, unless you choose an ETF (exchange-traded fund), only update their stock prices, or net asset values, once every day.

This eliminates the need for you to be glued to a screen or to fret over a fifty-cent move in a blue-chip stock that should not give you any concern.

Conclusion

If you have an aggressive mindset and a high-risk tolerance, investing in equities is the way to go. They can assist you in accumulating sufficient funds for various life goals, particularly long-term ones, and ensuring that you can address them with ease.

Investing in Equities

What is the 7 year rule for investing?

With a projected yearly return of 7%, divide 72 by 7 to discover that your investment will double in 10.29 years.

Are equities high risk?

Equities are widely regarded as the riskiest asset class. Investors in equities must assess the risk vs the potential return. In finance, risk and return have a positive correlation. The more money an investor can make on a specific investment, the more money that the same investor stands to lose.

What is the difference between stocks and equities?

The major distinction is that, whereas equities represent a trading or non-traded position in a firm, stocks are normally tradable equity shares of a company that can be distributed to the general public via stock exchanges.

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