Experienced investors whose main objective for investing is capital growth usually turn to equity investments since it affords them more opportunities to grow their money. However, investing in equities can be quite tricky and beginner investors could lose a large amount of their capital if they’re not armed with the proper knowledge to navigate this asset class.
Investors of all levels should understand the basics before adding equities to their portfolio to ensure that it truly meets their investment objectives.
What does equity investment mean?
To understand what an ‘equity investment’ is, it’s necessary to break it down to the basics.
Equity refers to a private or public entity’s net value. For companies, this equity is mirrored by its stock, which is determined once it lists publicly in an exchange. The stock is further broken down to share units for investors to purchase or trade.
Equity investment refers to investments in publicly listed entities or companies whose equity shares are traded in exchanges. The shares that investors purchase entitles them to partial or beneficial ownership in all underlying assets.
Equity investments refer to individual shares, private equities and shares in funds that manage equity portfolios. These types of investments allow investors to purchase shares and become part-owners and beneficiaries of the underlying assets, which may be a company, a trust or another publicly listed entity.
Though equity investments are purchased and traded in regulated exchanges, high-net-worth investors also have the opportunity to access and invest in private equities.
Bonds are not equity investments because they are classified as debt investments. This means that, instead of receiving part-ownership of the underlying asset, investors act as lender to the underlying entity.
What are private equity investments?
Private equity investments refer to equities held in private companies—or companies that have investor funding but are not listed in public exchanges. Private equities are typically only accessible to high-net-worth and institutional investors who can contribute a large sum of money to the underlying entity.
Since private equity investments aren’t available in securities exchanges, investors can only access them through private equity (PE) funds.
Some examples of private equity investments are venture and growth capital, debt financing, buy-out and fund of funds.
Equity investment styles
When creating an equity or shares portfolio, investors can opt to adopt certain equity investment styles that would suit their objectives and risk appetite. This includes choosing the market capitalisation of the underlying company.
Investors can shortlist the companies to consider for their portfolio based on their personal objectives and the style that matches their goal. For instance, some equity investors who focus on profit may choose any of the three styles listed below.
A growth investment style refers to when an investor focuses on accumulating assets that have a high potential for capital growth, such as companies in their expansion phase or those that are experiencing revenue growth due to past actions.
Value investment style refers to investors who search for and acquire undervalued assets that they believe would experience growth. The idea is that investors can profit from the undervalued asset’s price increase once its value is corrected.
One of the most popular value investors is none other than Berkshire Hathaway Chief Executive Officer Warren Buffett.
Blend investment style refers to the style of building an investment portfolio that combines the advantages of growth and value assets and the stability of conservative assets.
Equity assets may also be selected according to the underlying asset’s market capitalisation and/or the fund manager or investor’s management style (active or passive).
What are equity investment instruments?
Equity investment instruments are the legal documentation that serves as evidence for an investor’s part-ownership of the underlying company. This may refer to the stock or share certificate issued by the company to its investors.
The most common equity investment instrument categories are described below.
These are shares issued by publicly listed companies that are available to retail investors. These usually come with voting and dividend rights that are proportional to the number and class of shares an investor owns.
Similar to common shares but with a higher priority afforded to owners. Preferred shares usually pay higher dividends but also cost higher than common shares.
This refers to an investment asset, such as a bond or preferred share, that may be converted into a common share when certain conditions are met. The conditions for conversion are included in the investment’s prospectus.
This refers to shares issued by companies to protect the rights of existing shareholders in the event of a stock split or other similar circumstances. Subscription rights allow existing shareholders to purchase a number of common shares at a discount as a way of preventing their shareholder rights from dilution.
What are some equity investment risks?
Equity investments are exposed to various market forces that can affect the value of the underlying investment. Before investing in equities, investors must first understand what risks they will be exposed to and determine if the benefits outweigh the risks.
Some common investing risks to consider are valuation, currency and performance risk and liquidity and volatility.
Valuation risk refers to the danger of purchasing a high-priced stock that may turn out to be overvalued. A successful businesses in its growth phase could trade at sky-high prices, however, investors must discern whether the potential yield truly justifies the high price or it is simply inflated due to its current performance.
Before purchasing expensive but attractive shares, investors should first consider if they are really good investments at their current high price. At high pricing levels, even a slowdown in performance could lead to depreciation and reduce the expected returns to nil.
Equities are generally liquid assets, which means the investor can exchange them for cash when needed. However, some equities that are acquired through funds may not present the same degree of liquidity that individual equities offer, especially when prices plummet. In some cases, the fund manager can freeze the fund to prevent investors from taking their money.
Liquidity is also a cause for concern when the chosen equity investment or fund experiences a spike in volatility due to changing market conditions or issues with the underlying asset(s).
Investors who seek opportunities for financial growth face the risk of currency movements or volatility, especially if the asset is acquired from a country with an unstable economy.
Equity funds sometimes don’t perform as well as expected due to a host of reasons, such as any of the risks above, under diversification, over diversification, asset selection, the fund manager’s skill, bearish markets and, sometimes, even financial crises.
Are equity investments taxable?
Equity investments are taxable but there are some tax concessions that the Australian Taxation Office (ATO) allows investors to apply in their tax return, such as franking credits, offsets, rebates and exemptions.
Investors should understand, however, that different investment assets may have different tax treatments even if they belong to the same asset class. It’s best to ask a licensed investment professional about how an asset can affect their tax return before purchasing them, especially if the asset will be held for the long term.
Likewise, it’s important for investors to improve their financial literacy so that they can avoid costly mistakes when investing.