In the world of finance, you will find that there is a lot of jargon and lexicon that gets thrown around as if common sense. Among the myriad of terms, “equity investments” is a term that seems to float around your local broker’s office like the stale air-conditioned office air.
As such, today, we shall be discussing the concept of equity investing in depth. Specifically, we will be covering the following:
- What Does “Equity Investment” Mean?
- Why Invest in Equity Investments
- Types of Equity Investments
- Other Types of investments
- The Advantages of an Equity Investment
- The Risks Involved
What Does “Equity Investment” Mean?
An equity investment refers to acquiring ownership stakes or shares in a company or asset by an individual or entity.
Now, this is done with the expectation of generating a (decent) ROI. You, the proverbial investor here, become a partial owner of the company and holds a proportionate claim to entity assets and earnings. Your (again, theoretical) return is typically realized via dividends, capital appreciation, interest payments, or by selling the shares at a higher price than the initial investment.
Equity investments pop up in the stock market, private equity, venture capital, and other complicated forms of ownership in businesses and/or assets.
Why Invest in Equity Investments?
Investors flock to equities as they tend to offer capital gains, leading to robust wealth creation (that 9 to 5 isn’t enough to make us rich, unfortunately).
As well, these investments tend to offer returns in a diverse set of ways and different levels of market risk. A mutual fund tends to offer safer returns than common stock traded on a stock exchange, for example.
Types of Equity Investments
This is likely to be the one most people are familiar with. Common stocks are we are bought and sold on the stock market. Common stock represents partial ownership in a company, which is sold on a supply and demand basis (stipulated by the share price, which is the going market price for the stock).
The company decides (after an Initial Public Offering) how many shares to issue and at what price.
These transactions tend to take place on centralized exchanges, the stock market or stock exchange, that is regulated and closely monitored. Stock exchanges tend to vary, with these markets for publicly traded companies existing all over the world (ex., The New York Stock Exchange).
The price of this equity investment is determined by what is colloquially (and lazily) referred to as “market forces.” Essentially, an innumerable amount of different risk factors (like geopolitics, rising inflation, interest rates, natural disasters, and everything in between) can send an investment in a common stock soaring or plummeting.
As far as equities go, common stocks are the most accessible form of investing for the Average Joe (or Jill) investor, especially with the rise of online brokerages.
As a savvy investor (which I am sure you are), the stock market can be attractive as aside from the capital gain from the appreciation of the stock price. You can also “win” by earning dividends (essentially payments handed out by the company to investors).
Exchange Traded Funds
Exchange traded funds (ETFs) are equity funds that are comprised of a portfolio of assets such as common stock, bonds, or various commodities (such as nuclear, which we covered here).
As far as equity investments work, ETFs seem to be a preferred entry point for investors worldwide, as they help spread risk for investors across multiple companies and/or investment sectors.
For the average investor, an ETF offers an easy way to diversify, get investing with some sort of transparency, and dial down one’s exposure to external market risk (like inflation risk, for example, in a single nation).
Equity Mutual Funds
Sometimes, for the individual investor, there is not enough time to research and assess individual companies and stocks. That is where an equity mutual fund may come in handy.
Equity mutual funds are essentially pools of funds (a fund house, if you will) where said funds are invested into various equity shares. This is ideal for those who want to start investing in equities but may not have the education or the knowledge to conduct thorough due diligence (or, as the finance bros call it, DD).
For the investor, equity mutual funds offer a low-risk way to get exposure to multiple companies in various sectors. Due to the well-diversified nature of this particular investment (as compared to other assets), price movements of a single equity will not impact the mutual fund that much. Although, let’s not get over-excited, as this investment is in no way completely free of risk for individual investors.
Private Equity Investments
If you have ever spent any considerable amount of time with your finance friends (I wouldn’t recommend it), you most likely have overheard them discuss having capital invested into private companies. This, my friend, is private equity investing.
Typically, this investment vehicle is reserved for high net-worth investors (unless you watch our video, where we explain how anyone can get into it) looking to tap into the promise of a company before it goes public. As well, companies are set up with the express purpose of investing in these companies.
These types of equity investments are typically for investors who want to help these companies scale and accrue value over a desired time horizon. Private equity investors bring not just
As the invested companies grow and become more profitable, the value of the private equity investment also increases (which means potential profits for investors also increase). After a certain period, the private equity investors may decide to sell their stake(s).
This kind of equity investment typically involves a longer investment horizon compared to more traditional equity investments. You need to be patient, and this type of asset allocation strategy tends to be quite risky.
Other Types of Investments
It is worth talking a bit about other types of investments and how they work, as well. Equity investments may not be for everyone, and as such, there are still a multitude of options.
Money Market Instruments
Money market instruments are non-equity investments that take the form of short-term debt obligations issued by governments, corporations, and financial institutions (typically with high creditworthiness, as nobody wants to be embroiled with an issuer with astronomical liquidity risk).
As an investment, these instruments allow the issuer to raise funds (often quickly) to meet current obligations while at the same time being a viable investment for investors concerned about liquidity risk and general asset safety.
Now, this investment vehicle tends to have a few distinct characteristics:
- Short-term maturity
- Robust credit quality
- Stable (comparatively)
Again, I want to stress that this non-equity investment depends largely on the creditworthiness of the issuer. So, if you are thinking of investing in these instruments, make sure to keep that top of mind as you do your research (and obviously, this is not investment advice).
Fixed income deposits are (besides being the most boring) one of the most common investments, aside from common stocks.
These investments tend to be offered by banks and various other financial institutions, governments, and companies as an investment vehicle to achieve one’s financial goals (assuming, of course, you have goals which I hope you do). Fixed income deposits offer a fixed interest rate, maturity date, and finally, any other applicable terms.
If you would describe yourself as risk-averse (or, as some would lovingly call it, boring), then this conservative investment strategy may be for you. For multiple investors, the reliability of this investment is the most feasible investment strategy, especially for those who aren’t your everyday financial advisors.
The relative stability of the investment (again, as compared to other investments) is the most attractive feature here. There is some level of liquidity risk, however, as one must assess the creditworthiness of the borrower (are they a credit risk or not is really the question you have to ask yourself).
The Advantages of the Equity Investment
For the average investor, the sheer amount of equity markets means that risk can be allocated and spread more evenly. Spreading risk allows an investor to protect better their (precious and, lately, hard to come by) capital gains.
Ability to keep tabs
An equity market often offers an investor the ability to monitor the performance of their chosen equity vehicle closely. Equities can be self-monitored or via financial advisors and other organized groups that specialize in such.
This, thus, gives you some light into what you are investing in and how it is doing, as opposed to being left in the dark for an unspecified period of time.
Hedging against inflation
I am sure we are all aware of that pesky little thing called inflation (the force that is making your grocery run feel like a luxury).
An equity investment is a hedge against inflation as one of these instruments can provide a return that outpaces said inflation, helping offset the proverbial gut punch (or wherever you keep your wallet, I guess).
Equity investing, let me say, does not come without inherent risks. Here are some of the main risks involved:
As an investor, if your invested assets are exposed to the wildly interconnected global economy (which, inevitably, they would be), widespread inflation could start a domino effect that results in your equity investment(s) losing value. Inflation and interest rates are linked in rather complex ways (we give an example here) that would take far too long to get into now.
Now, especially with investment vehicles issued by the government or PEEs (politically exposed entities), politics can play a major factor in the value of an equity investment.
Policies that are viewed as unfavorable to whatever investment you find yourself immersed in can lead to the rapid erosion of the value of said investment.
As well, investing in places without the proper safeguards or robust rule of law poses that same risk of value erosion.
Foreign currency risk
For all you investors out there, oftentimes, the entities you are invested in (for example, a portion of a company’s assets) may not hold all their assets in the common currency.
A lot of the time, some of these entities will be (at least partially) embroiled in foreign currency as a hedge against their own (as well as a myriad of other reasons we will not get into today). A nosedive in this foreign currency can mean that your precious investment takes a pointed nosedive.
The Last Word
So, what am I trying to say? Essentially, equity investments are a robust and useful tool for wealth creation, preservation, and growth. In fact, participation in such markets is a common and robust way to participate in the global machine that is the economy.
On another note, due to the variety of the types of investment vehicles, the differing risk levels, and the varying complexities, there is something for everyone. Whether you are a risk-averse novice or a risk-loving investor, equity investing offers a vehicle for everyone. Not everyone wants to drive 200km/h in a Lamborghini. Some people are okay with doing 50km/h in a Honda Civic.
Lastly, as always, do not dive into waters you cannot make out. That is my roundabout way to say, consult a financial advisor if you need one.
This is not financial advice by any means. Please do your own research before investing.
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