Welcome to our Education series that aims to explain various investment concepts in a friendly, clear, and precise format.
Here, we will look at equities.
When people talk about investing, they are usually talking about equity investing. Stocks, shares and equities are all interchangeable names for the same thing, and in this article we will explain what they are and why you may want to hold them, as well as a few of the key risks to be aware of.
What are equities?
The easiest way to think of equities is when an individual buys a share of a company that is traded on a stock exchange, such as the S&P 500. When you buy a share in a company, you become a co-owner of the company. For example, if you go out and buy one share of Apple Inc, you become a part owner of Apple Inc, albeit a small one.
If Apple Inc does well financially, you will benefit either through the share price appreciating or Apple paying a dividend (or both). If Apple does badly, you will suffer, either in the form of the share price falling and your holding potentially being worth less than what you paid for it or else the dividend being cancelled.
In extreme cases the share price of a company can fall to zero, meaning you lose all the money that you invested. Because of this, and other factors, equity investing is often considered one of the riskiest ways to invest.
Benefits of investing in equities
- Asymmetric returns
In a nutshell, the downside is likely to be limited, but the upside can be unlimited. In most cases, the maximum that you can lose as a shareholder is 100%. That is, the share price goes to zero. But, when things go well, your gains can be unlimited. There is no upper limit on the share price. So as the share price ticks up, so does the gain.
- Best long-term returns
When we consider traditional investments – cash, bonds and equities – studies have shown that equities tend to have the highest return profile when considering longer periods of time. In the interim, there will be fluctuations and these can be dramatic at times. But if investors stay invested in equities, then they will find that equities generally tend to deliver better returns over the long term.
Drawbacks of investing in equities
- More volatile
Share prices fluctuate and this can be uncomfortable for individuals. We only need to cast our minds back to March 2020 when the COVID pandemic was underway, to find some dramatic share price action. For this reason, equities are usually not appropriate for individuals who might need to call on their investment pot in the near-term.
- Risk of loss
As mentioned above, there is a chance of permanent loss of capital when investing in equities. If you invested all of your cash into one company and that company were to go bankrupt, you would lose it all.
Summary
There are clear benefits of investing in equities, but you need to be aware of the risks too. Generally speaking, investing in equities tends to be more appropriate for those who are willing to be invested for a longer period of time.
If you would like to discuss equity investing, please don’t hesitate to get in touch.
Risk warning: With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning. This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.