Smart long term investors include equity investment as part of their asset portfolios.
What is an equity investment
An equity investment is an investment into a commercial enterprise. We expect an equity investment to generate a financial reward eventually.
Shares in companies that are listed on a stock exchange are a type of equity investment. We can buy parcels of shares in Australian companies. The big Australian banks and major retailers are listed companies. We know what these companies do to make money for shareholders.
Ownership of motorways and airports are also equity investments.
The growth part of an investment portfolio is consists of the shares or equity investment in real businesses. As a part owner of a business your equity investment or share of the business, entitles you to share in the profits of that business.
What are the rewards for owning an equity investment
Shareholders expect to share in the profits of the business. Firstly, shareholders are rewarded with part of the profits earned by the company each year. Companies distribute profits by means of dividend payments. Australian listed companies usually pay out a dividend twice each year.
The dividend paid out to shareholders is usually on a fraction of the profit earned by the company. The company must pay income tax on its business income. Then part of the after tax income would be retained by the company to finance its business activities.
Secondly, shareholders expect that the business of the company will prosper so that the value of each share would increase over the long term. You would expect that the company you invested in would expand its business, so that its profits grow. Thus you would expect that the dividends would also grow. Then when you want to sell your shares someone else would buy them at a higher price than you paid.
What if my equity investment goes sour
Alas not every business is successful and profitable. Some businesses become irrelevant and former customers no longer want to buy their products. Do you still buy film for your camera and have your photographs developed? The makers of film for ordinary families stopped making a profit when we switched to digital photographs.
When there are no profits to distribute the shareholders receive no dividends. With no dividend reward forthcoming, the value of a shareholding can contract sharply.
A company that wants to stop running its business might be able to sell its assets. Any assets remaining after all the company’s creditors have been paid might be available to be distributed to shareholders. You might get paid something small if the company you held equity in ceases trading.
When a company no longer has enough money to pay its bills then it must stop trading. A company is insolvent when it does not have enough assets to cover its debts. In Australia, the directors cannot keep operating an insolvent business. If you own shares in an insolvent business then your shares are worthless.
Why include equity investment in my portfolio
Well run businesses that respond to their customers’ needs usually continue to earn profits for shareholders. Good businesses could actually increase the dollar amount of profits over the long term. The resulting stream of dividends distributed to shareholders also increases over the long term.
But remember not every business would have a good result every year. Hence the profits available for shareholders could stay flat for a few years. Successful companies try not to reduce the dollar amount of dividends paid in respect of each share. When the profits decline markedly then the dividends do drop or cease totally.
Including some equity investments in your portfolio could provide a dividend income that would increase in dollar terms over time. The dividends received from a bundle of shareholdings in different companies would be expected to keep pace with inflation over the medium term. Also the price that another investor would pay for your shares would be expected to increase to reflect the growing stream of future dividends.
But remember there are no guarantees with equity investment. We expect that the companies we invest in will remain profitable and paying out dividends. We also expect that other investors will want to buy our shares later on.
As shareholders we are part owners of a business. We share in the profits only if that company continues to generate more income than it needs to pay for both its current expenses and the costs of building the business to generate profits for future years. If there are no profits available to distribute then shareholders would not be paid a dividend. When dividends are suspended then it might be hard to find a buyer for your shares.
Over a period of at least seven years, a bundle of shareholdings spread across many industries could be expected to generate a higher average investment return than just parking your money in a bank account.
Equity investment within a long term investment portfolio
If you have an investment period of at least seven years then you might consider including some equities in your portfolio. A recent retiree in good health could consider a balanced portfolio that included about 60% equity investments and the other 40% into fixed interest securities and bank deposits.
Over time, the equity part of the portfolio could be expected to grow in value and to generate a growing income on average. Therefore if you are looking at another twenty years of retirement then some equity investments could help maintain your investment income.
But remember that the value of your equity investments could go down sometimes. Also your total dividends payments might not grow evenly or at all. Thus, you would not want to need to sell your equity investments to pay for your basic living costs.
If you are young, in good health, with a generous salary, no dependants and no mortgage then you might enjoy the excitement of having a large part of your personal investments in equities. A diverse bundle of shareholdings could grow to a valuable portfolio over the next thirty years of your working life. Having other assets and income to meet your living costs over those three decades could spare you the misfortune of having to sell down your shareholdings when investment markets are subdued, the very time when the risk of retrenchment is real.
In contrast, investment in equities might not be smart if you are entering aged care because you are frail. Most aged care entrants have a life expectancy of less than five years so they would not reach the reasonable minimum equity investment term of seven years. The other beneficiaries might be distressed if their part of the eventual estate is reduced in dollar terms because the share values are down.
Equity investment for only a short term?
Wise investors only buy equity investments that are expected to be profitable eventually. But ‘eventually’ might be very long term for a start-up company developing a new product. During the development stage new investors might not want to buy the promise of eventual profits. Therefore if you need to sell your investment to pay an unexpected bill then you might lose money.
The market value of good quality equity investments in profitable businesses can fluctuate because overall economic conditions are changing. Thus the value of your equity investments could go down sometimes. Later the market values might go up again. If you have to sell your equity investment urgently because you need cash then you might have to sell when the markets are down. Then you might not get a good sale price for your shareholdings.
The risk of not getting any profit when you sell your equity investment could be higher in the early years of your investment. Thus equity investment might not be suitable for money that you need for living costs within the next five years. For some investors, money that could be needed for expenses over the next ten years might be better invested in less risky assets than equity investments.
Financial advice before buying equity investments
Before you start buying equity investments is a good time to think about the risks as well as the potential rewards. Ask an independent financial adviser about your situation before you commit to buy equity investments.
If you would be stressed or financially distressed when your equity investment dropped 20% in value, then maybe equity investment is not for you just now. Similarly, if you are likely to need your money for another purpose within the next five years, then maybe equity investment is not for you just now.
Financial Care Services your independent financial adviser
Financial Care Services is an independently owned and operated financial adviser specialising in seniors in transition. Christine at Financial Care Services advises seniors who are moving into new accommodation. Christine can help with strategies for investing any money released from the sale of your home when you are moving into independent living, a lifestyle community retirement village or residential aged care.
Christine can also help you understand the costs of living in your new accommodation. Centrelink could change your Age Pension rate and levy means tested fees if the family home is sold to pay for your aged care. Just downsizing your independent housing could trigger a reduction in your Age Pension.
Contact Financial Care Services for independent financial advice
Contact Christine at Financial Care Services to arrange a consultation as part of your transition planning. Remember to ask for independent financial advice before you buy an equity investment with your extra funds. That money ‘left over’ from the sale of the family home might be needed for your basic living expenses.
Contact Financial Care Services by email to receive the Financial Services Guide for Christine Hopper of Financial Care Services.
Call Christine at Financial Care Services on 03 9808 0338 to make an appointment for independent financial advice about transitioning to new accommodation.
A consultation with Financial Care Services helps you understand your potential seniors living costs together with the DVA and Centrelink implications of rearranging your assets, leasing or selling the former home.
Financial Care Services welcomes clients from Melbourne and beyond.
Assistance with completing Centrelink forms including the Commonwealth aged care means testing forms is available to clients of Financial Care Services.
Financial Care Services is licensed to offer investment strategy advice and to assist you to invest. Financial Care Services charges flat fees based on the time and expertise required to advice each client. Financial Care Services does not base fees on the value of your assets nor do we accept any commissions or payments from other service providers.
Arrange an appointment for further confidential, independent and professional advice about DVA, Centrelink, lifestyle or financial issues please contact Christine Hopper 03 9808 0338 or by emailing firstname.lastname@example.org.
Disclaimer: The information contained in this website is of a general nature only and does not constitute “financial advice”. You should obtain your own personal financial advice before investing any money or moving in to any retirement village, lifestyle community or aged care facility. Financial Care Services is licensed to provide financial advice to individual clients based on their personal situations. © 2017 Financial Care Services Pty Ltd. All rights reserved.