Equities are companies run by really smart women and men who are held accountable by a board of directors. This accountability is helpful but does not guarantee that a company will be successful in the long run. Some companies may lack key leadership or be bought-up by larger companies. In extreme examples, some companies may go out of business due to the inability to generate growth and profit. Equities are investments in companies of all sizes and all over the world.
There are several ways to invest in equities. You may own stock in an individual company. Companies tend to reward employees with company stock and may offer the ability to purchase more via an employee stock purchase plan. You may also own equities in mutual funds or exchange traded funds (ETF) inside your 401k or 529 plan. One of the benefits of owning equities in mutual funds or ETFs is the diversification you gain in this form of ownership. Instead of owning a single company you own hundreds of companies. Each mutual fund or ETF includes a description of what type of equites they hold and their stated objective. Some funds invest solely in companies isolated in a particular industry such as technology, finance, or health care. Other funds focus on company size or geographic location. Combining equities together in a single fund allow the investor the opportunity to own a wide and broad selection of companies. Why? It’s easier to gain diversification in a fund or ETF then having to own all the individual stocks themselves.
Some funds and ETFs have an active team of managers review each company and their performance on a quarterly basis. This team of managers makes decisions on the performance of holdings within the fund. New equities may be added, while others are sold, in moves that are similar to a baseball coach changing pitchers late in the seventh inning. This is referred to as “active” management of equities because the team of managers are consistently making adjustments on what companies to hold in the fund.
Another approach is to create a fund that doesn’t have a management team and instead seeks to mirror an index. For example, a fund may be created to mirror the S&P500 index, which contains some of the greatest companies in our country. This approach tends to be less expensive as no team of managers is present. These lower fund expenses are passed along to the investor. I’m not prepared or interested in debating which approach is better. This is a conversation that’s up to you and your financial planner.
What is important to understand is how equities grow over time and may pay dividends. These dividends offer the ability to hedge the rising cost of living over the lifespan of your plan. In addition, the growth of these companies is reflected in their increasing value and prices over decades. Systematically liquidating equities at higher prices overtime creates income for yourself and family. This also allows you to pay for more future fun and living expenses as the higher costs of tomorrow arrive.
You may find yourself asking, “Given the recent price volatility should I be liquidating equities now?” The answer depends on your plan. A good plan has ample cash reserves, as we’ve discussed, to utilize in times like these. It doesn’t make it any less stressful to watch your equities temporally contract in value, but it’s best to use cash set aside in advance for income needs and to add some peace of mind to your plan.
Your plan and planner should review the types and percentages of equities that are right for you. Equities by design contain risk as we’ve discussed. Price volatility that we’ve seen and experienced the past six weeks is present also. Keep in mind risk and volatility are two separate entities as we covered in an earlier post. Equities by design offer a higher probability for income success long term when held accountable to your written plan.