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. If you have more questions about equities or investing in general, a financial advisor can help you plan our your investments.
The Basics of 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 the stocks you own declines.
Conventional wisdom states that young people can afford more equity exposure, and therefore will likely want more stocks because of their potential for sizable returns over time. As you near retirement, though, 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 get older.
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 that’s not the only way you can come out on top by owning equities.
For example, companies pay dividends out of their own profits and into the pockets of their shareholders. These periodic payments aren’t guaranteed, but when available, they can provide major benefits. As an investor, you can either reinvest your dividends or take them as income.
If you own equities, it’s important to understand the difference between capital gains and dividends. A capital gain is the difference between the price at which you bought shares and the price for which you sell them. There are both long- and short-term capital gains, each with their 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 Is Preferred Stock?
Owners of preferred stock get more access to earnings and assets than owners of “common stock” can claim. Preferred shareholders are more likely to get regular dividend payments (usually at a fixed rate) and they 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.
In the event that the company goes bankrupt or is liquidated, preferred shareholders have dibs on assets and earnings before common shareholders. In the hierarchy of who gets to take a company’s assets if it folds, bondholders are at the top, 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, complete with salary, health insurance, a 401(k) and equity. What exactly does “equity” mean in that case? It means that you either have an ownership share in your new company now, or you will have 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 stock at a preferential price.
Equity alone does not a great job offer make, however. Unless your company goes public or is sold (these are known as “exit events”), your equity won’t pad your bank account. Plus, since your salary is already tied to the fate of the company, the more company stock you own the more financial eggs you’re putting in that one 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, which is referred to as “selling low.” But to be successful in the equities market, you’ll need to do the opposite of what feels right. That means buying low and selling high.
If you don’t think you can overcome the natural tendency to buy high and sell low, you may be better off staying out of those decisions altogether. An index fund that tracks the general market will take the power of buying and selling out of your hands.
Tips for Investing
- A financial advisor can help create a financial plan for your investment needs. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A well-rounded investment portfolio should include more than just equities. You should consider diversifying your assets across other securities, like bonds, options, mutual funds, exchange-traded funds (ETFs) and more. To figure out what your portfolio should look like based on your desired risk level, use SmartAsset’s asset allocation calculator.
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