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Investment Basics

Equities - An Investor's Primer

"I'm in stocks" certainly has a different meaning today than it did in Puritan times, and one of the best ways to hold stocks, rather than having stocks hold you, is with an equity mutual fund.

"Equities", "stocks", and "shares" are three words that often mean the same thing. If you invest in an equity mutual fund, you indirectly own common stocks or shares. Common shareholders are the owners of a public company and provide the equity capital to carry on or expand the business.

If the business prospers, common shareholders may receive dividends, or make capital gains if their shares are sold at a profit. If the business fails, common shareholders may lose their entire investment.

The rights and advantages of common share ownership are as follows:

  • Potential for capital appreciation
  • The right to receive any common share dividends paid by the company
  • Voting privileges
  • Favourable tax treatment of dividend income and capital gains
  • Marketability - share holdings can be increased or decreased
Capital appreciation can derive from an increase in the share price or from stock splits. The price of shares follows the law of supply and demand -- if many people want to buy a stock, the price goes up. Demand is usually based on the value that people see in the company issuing the shares. This can be present value (in the case of a highly profitable company) or future value (in the case of a company with small current profits but a bright future).

Because most companies prefer to keep their share price in a popular range from $10 to $100, a stock split may be used to bring a high-priced stock back into this range. If you own 50 shares of a $100 stock and it splits two-for-one, you will own 100 shares of a $50 stock. If it splits four-for-one, you will own 200 shares of a $25 stock. The total value is unchanged, just divided among more shares. Consolidations work in the opposite way -- the total value is distributed among fewer shares, thus increasing the share price.

Common stock dividends may be paid by a company if there are profits left after paying expenses, bond interest, debenture interest, and preferred dividends. The board of directors determines the dividend policy, and mature companies may pay dividends while growing companies may retain their earnings to fund future growth. Some companies designate a specific dividend that will be paid each year, while others prefer to retain dividend flexibility.

Dividends are included in determining the annual yield for a common stock, with regular dividends usually increasing the demand for the stock and the stock price. Voting is a right that is conferred on some, but not all, common shares. If you invest in a fund that, in turn, buys voting shares of a company, the fund exercises those voting rights for you.

The dividends received from common share ownership have preferential tax treatment over the interest received from corporate bonds. This is to avoid double taxation since interest payments on bonds, but not dividend payments on stocks, are tax-deductible by the company.

If you sell stocks or shares in a public company or equity mutual fund at a profit, you will earn capital gains. Since capital gains also have preferential tax treatment over interest income, an equity fund may be advantageous over a bond fund. Your financial advisor can help you determine which investments are best for you.

So, if holding stocks appeals to you, talk to your investment advisor about how to participate in an equity mutual fund. While stocks were once used to build character, now they can be used to build the foundation for a strong investment portfolio.

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