Equities, often referred to as stocks, represent ownership in a company. When you purchase equities, you are essentially buying a piece of the company, entitling you to a share of its profits and assets. This form of investment is popular among both individual and institutional investors due to its potential for high returns. However, it also comes with a certain level of risk, as the value of equities can fluctuate based on market conditions, company performance and economic factors.

If you have more questions about equities or investing in general, a financial advisor can help you plan out your investments.

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 the stocks you own declines.

There are two main types of equities: common and preferred stocks. Common stocks are the most prevalent and grant shareholders voting rights at company meetings, as well as the potential for dividends. Preferred stocks, on the other hand, usually do not come with voting rights but offer a fixed dividend, making them more stable in terms of income. Both types of equities can be an integral part of a diversified investment portfolio, each serving different financial goals and risk tolerances.

For those considering adding equities to their investment portfolio, it’s important to approach this decision strategically. Diversification is key, as it helps mitigate risk by spreading investments across various sectors and asset classes. Investors should also consider their financial objectives, time horizon, and risk tolerance when selecting equities. By taking a thoughtful and informed approach, investors can harness the potential of equities to enhance their financial future.

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 that investors like equities to be a part of their portfolios. Here are some of the main benefits that investors have in mind when investing in equities:

• Reward Potential: For a limited investment amount, you can get access to a huge potential payout down the line if a business exponentially grows in value.
• Dividend Payments: Some equities pay out dividends from capital gains, which are payments from the profits that the business makes to shareholders. This provides income while the overall value of the business is increasing.
• Diversification: You can invest in a large number of 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, it’s important to invest with the right strategy in mind so that equities can 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 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 a 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 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 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.

If 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 one when your equity “vests.” In other words, when it becomes official because 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. 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.

Frequently Asked Questions

How Is Equity Used by Investors?

For investors, equity is a crucial metric. When evaluating a company, investors might use shareholders’ equity to assess whether a stock is priced fairly. For example, if a company typically trades at a price-to-book value of 1.5, an investor might hesitate to pay more than this unless they believe the company’s future prospects have significantly improved. Conversely, an investor might consider purchasing shares in a weaker company if the price is attractively low compared to its equity.

How Is Equity Calculated?

Equity is calculated by subtracting total liabilities from total assets. This calculation can be easily found on a company’s balance sheet. For homeowners, equity is determined by taking the current market value of the home and subtracting any outstanding mortgage debt or liens.

What Are Some Other Terms Used to Describe Equity?

Equity is often referred to by several other terms, including shareholders’ equity, book value and net asset value. While these terms can have slightly different meanings depending on the context, they generally describe the value remaining in an investment after all associated liabilities have been paid off. In real estate, equity specifically refers to the difference between a property’s fair market value and the outstanding balance of its mortgage loan.

Bottom Line

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, which often means buying low and selling high.

Tips for Investing

• A financial advisor can help create a financial plan for your investment needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel 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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