Equities are probably the most well-known asset class. They’re popular for their ability to provide returns (capital appreciation) by participating in a company’s growth, profits or potential.
As you can imagine, there’s an extremely wide variety of companies, sectors and geographies you can choose from, so there’s many ways to diversify your portfolio. They also tend to be among the more aggressive asset classes, meaning there’s lots of opportunity for your investment to go up… but also runs the risk of going down.
Want to learn more about what an asset class is and other types? Check out our What is an Asset Class? article.
To get you a better overall picture, let’s run through some of the basics, and risks and benefits of equities.
How do equities work?
As mentioned, equities give you exposure to the growth of a company. A company will sell (or issue) stocks or shares to raise capital for their business operations. Investors can then purchase those stocks on exchanges—such as the Toronto Stock Exchange. You can also purchase groups of stocks or equity solutions in pooled investment solutions like mutual funds or ETFs.
Once purchased, the owner of the stock now owns a fraction of the company and can profit from the company’s earnings. These earnings can be passed to investors in two ways:
This occurs when the market price of the stock increases based on a variety of factors, such as corporate earnings (both current and prospective), public perception, etc. The owner of the stock will “realize” their gains or growth on their investment when they sell their holdings for a profit.
But remember, the market price can also go down. So, if you sell your holdings at a lower price than what you purchased them for, you “realize” the loss and end up with less than you had in the first place.
Some equity funds or stocks pay their shareholders periodically (typically quarterly or annually) with dividends, allowing them to benefit from some of the earnings while they hold the stock. Investors then usually have the option of taking the dividend in cash or reinvesting back into their portfolio.
What are the benefits?
There’s lots of benefits to investing in equities—hence why they’re so popular! But the biggest draws for investors are the opportunities for capital appreciation and diversification.
Equities can offer some of the greatest return potential compared to other asset classes. This makes them a popular choice to help investors achieve their financial goals, particularly those who have longer time horizons to make up any potential losses.
While there’s risk investing in a single stock, you can mitigate that by investing across a variety of equity markets. Some primary examples include:
- Canadian equities – Focus on Canadian companies and industries. The largest Canadian market sectors include, real estate, industrials, financial services, energy and materials.
- U.S. equities – Focus on U.S. companies and industries. The largest U.S. market sectors include, health care, technology, construction and consumer goods.
- Emerging markets equities – Focus on companies and industries in developing markets. While slightly riskier, these markets can offer higher return potential as their economies are newer with more room to grow.
- Sector-specific equities – Focus on companies within a specific industry. Perhaps you want to tap into the growth of the technology sector, or you want to invest in green energy—check out our Impact Portfolios. There are many solutions out there that can help you pinpoint a specific segment of the market.
Compared to some individual bonds, equities are quite liquid and are relatively easy to trade on exchanges. They’re not as liquid as cash, but, depending on the company, a close second.
What are the risks?
As with any investment there are some things to consider before you buy. But the risks with equities aren’t that unlike other asset classes.
The market value of a stock can go up or down for a variety of reasons (as mentioned earlier), and they can be very sensitive to external factors. We saw this recently with the COVID-19 pandemic. If investing in equities, it’s best to be able to ride out some of the tougher times and wait for values to bounce back.
Last to get paid
If a company goes bankrupt, creditors (i.e. bondholders) have legal priority to be paid back first. Stock or shareholders on the other hand are last in line to get back their initial investment.
Incorporating equity in your portfolio
As you can see, equities give investors some of the best potential to grow their investments, but they do come with some risks. That’s why it’s always best to ensure you’re diversified across the types of companies, sectors or geographies you’re investing in, or seek professional advice.
Our managed portfolios use a variety of equity solutions to maximize returns at different levels of risk, and we make it easy for you to invest in a portfolio that makes sense for you.