Equity Investment: A Quick Explanation

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Most investors are in the game looking to make a profit. If they stick with conventional investment tools, such as fixed deposits (FD), their principal investment will grow according to an interest rate closely linked to inflation. These are ‘safe investments’ that do not yield extraordinarily high returns.

However, equity investment can yield profits that far surpass inflation, although they come with one downside: risk. However, companies like Capshare, CaptableIO, Capbase, and Fairmint offer simple approaches to equity investment that allow users to manage this risk. Meanwhile, Fairmint goes a step further with its CAFÉ (continuous agreement for future equity product) that will enable investors to buy more equity in a company directly from a company’s website. This makes the process of trading equity relatively easier if not too easy.  

Here is a look at what equity investment is and how it can diversify your investment portfolio advantageously:

Understanding equity

Before launching into a detailed guide on equity investment, let us define a few terms:

Equity

Equity means having ownership in a specific company. When you have equity in a business, you are known as a shareholder. The hope is that, as time passes, the share value will increase as a company’s value increases, earning you a substantial profit should you decide to sell your shares. Additionally, as a shareholder, you are entitled to a percentage of a company’s profits each year.

Shares

Publicly listed companies are divided into shares, with each one constituting a percentage or fraction of percentage ownership. For example, if a company sells 1,000 shares, each share is worth 0.1%. If you were to purchase 50 shares, your stake in the company’s shares would be 5%. Owning shares is not the same as owning a company and having a say in what it does. As a shareholder, you invest your money, allow the owners to run it, and then receive your share of the profits.

Dividends

A dividend is the dollar payout per share from the company’s profit that each shareholder is entitled to. Companies do not allocate their entire net profit to dividends. They keep some for reinvestment purposes to keep the business growing. Only after such amounts are deducted do the figures show a final profit divided among shareholders according to how many shares they own. Following the example above, if a company declares a dividend of $20 per share, you receive a $1,000 payout.

What is in it for you?

Here are some benefits of equity investment:

  • The value of your principal investment in a share purchase grows as the share value increases. This is called capital gains.
  • You earn an annual passive income from dividends. There is no additional work necessary after you make your share purchase.
  • Should a company decide to offer more shares to raise capital, you might be entitled to the first bite at the apple before those shares are made available to new investors. This would allow you to increase your share ownership, thereby improving your potential for capital gains and dividends.

Understanding the associated risks

You might be wondering why everyone is not busily investing in the stock market if making money through equity investment is so easy. Truthfully, it is a great way to earn money, but only if everything goes according to plan.

Stock market volatility is what puts many would-be investors off plowing their money into share purchases. Recent events, including the COVID-19 pandemic, have proven that stocks can rise and fall from external factors. Internal factors, such as mismanagement or sudden financial losses, could cause a company’s share price to plummet.

Knowing what might precipitate such events and how the market will be impacted is practically impossible to determine. Sometimes, it happens out of the blue, leaving investors holding onto stocks that become all but meaningless overnight. This makes mitigating such risks a challenge.

Addressing risk challenges

Instead of trying to go it alone when choosing which companies are a stable investment, consider hiring an advisor. They use their expertise to determine if your proposed investment is sound and does not pose too great a risk.

Alternately, an advisor might create a balanced equity investment portfolio on your behalf. It contains high-, medium-, and low-risk share purchases. This approach ensures that you have a reasonable expectation of seeing dividend returns on your investment each year. These payouts might not be as significant if you have put all your money into a high-risk venture. Then again, you could have lost it all using this approach.

Conclusion

Most experts advise potential equity investors to dip their toes in the market by purchasing shares in established companies. With a bit of experience under your belt, you can spread your wings and find more high-risk, high-reward share investment opportunities. However, when it comes to such purchases, never invest more than you can afford to lose so that you do not wind up out of pocket and worrying about your financial stability.