Why Invest in Stocks?

“Wealth is created through ownership of the means of production (such as factories or raw materials) and contracting workers who generate more value than they cost.”

– Karl Marx

Written by Steve Nyvik, BBA, MBA, CIM, CFP, R.F.P.

Financial Planner and Senior Portfolio Manager, Lycos Asset Management Inc.

Originally Published December 2015 on "You and Your Money" at Money.ca

What is a Stock?

A company is a legal entity set up by a person or group of people for the purpose of operating a business. Such a company is incorporated under the legal statutes or acts a state/province/territory or country and such laws spells out the rights, obligations and liabilities of such a corporation. And in another statute or act, the taxation of company income is determined.

A stock is an interest in a corporation. It may represent financing for the business or it may represent ownership. The value of the stock depends on the characteristics and rights of that particular interest which are either codified under the statutes or the company articles (the laws) or subsequent document (like a prospectus) that form part of the company laws.

The statutes that a company operated under will typically define the rights, obligations and liability of the owner of a “Common Share”.

Typical rights of Common Shareholders:

• Right to receive annual audited financial statements
• Right to vote on issues brought forth at annual shareholder meetings
• Right to vote for directors of the board
• Right to a share in the profits that are paid out as dividends
• In liquidation of the company, right to the remaining assets after amounts owing (to governments, creditors, employees) have been paid in full

The liability of a Common shareholder is limited to the extent of their investment (company officers and directors have statutory obligations where certain liabilities can extend to themselves personally). So if you bought shares for $10,000, are a passive investor, and the company goes bankrupt, then the company creditors generally cannot come after you personally to satisfy any remaining company debts.

The business income of a company may be taxed at lower marginal tax rates than if taxed personally. This incentive may be commonly found to encourage entrepreneurs to risk their capital and time to create businesses to offer desirable products and services and to create employment.

Shares listed on a stock exchange provide liquidity for when one wishes to buy or sell. A private corporation may contain provisions that restrict the transfer of shares to others and on what terms.

Why become a business owner?

Karl Marx wrote that wealth is created through ownership of the means of production (such as factories or raw materials) and contracting workers who generate more value than they cost. The products or services are sold and any profit that results accrues to the business owner. Business ownership provides an opportunity to leverage off this excess added value that can generate a profit that could be many times more than what you could have earned on your own if you contracted out your labour. It‘s no coincidence that many people attribute their wealth due to owning a business.

 As the sole owner you have control over its success and all profits accrue to you. But the risk of failure for a small business can be high. Some company creditors might even be entitled to go after you for satisfaction of what they are owed. And there’s no guarantee of a profit or a livable wage for you and no guarantee of a capital gain when you sell your shares.

As a passive investor:

• You may not have as large an interest in the company and as large a share in the after-tax income;
• You have no control over the management decisions;
• You have no control over the payout of dividends;
• You are at the mercy of the collective wisdom of all persons interested purchasing or selling shares of the business should you wish to raise some cash.

But on the flip side as a passive investor of a stock with a history of good dividend yields, you gain freedom and receive a tax-preferred income.

Why invest in stocks?

Starting a business that hopefully becomes successful is one way to become rich. And then when you sell, you have a nice nest egg to fund your retirement. The other way to fund your retirement will come from your savings and how you invest it to grow so you will have enough when needed.

Investing in real estate is indeed one option for your savings. And indeed many people have become rich through real estate. As we all have to live somewhere, owning your home rather than renting normally makes good sense. And when you add in any exemption of the future sale of your home, that makes it that much more attractive. Where you borrow to buy your home, it is generally a good idea to repay your mortgage so that when you retire, you don’t have that financing cost.

Beyond your home and repayment of any financing, the decision on how to invest your savings in either real estate or stocks becomes an issue. There is no guarantee that land will outperform stocks through time or vice versa.

Buying real estate generally involves a substantial commitment of resources and possibly having the capacity to borrow. The trouble with such real estate is that where you rely on the property to meet your living needs, it may not be easy to sell the property at the time you need money to fund your living needs and also to get the price you need. If however the property generates rental income, hopefully the net income it generates is sufficient to meet your living needs. One problem with a rental property is that it needs to be managed. You have to make sure you have tenants that pay regularly, you have to maintain the property, and as the owner you have to deal with any problems that might arise at any time of the day.

The advantage of investing in stocks is the ability to passively invest in several different businesses to reduce your business risk by owning shares in several businesses. As the number of stocks in the portfolio increases, the overall impact on the portfolio due to one stock declining decreases. To fund your goals, you might receive dividends from such investments or to sell small amounts periodically. Where the stocks provide a decent dividend income that is sufficient to meet your living needs, you then can live more easier than worry about the fluctuations of the capital value. A further benefit as a passive investor is that you need not have to manage the business or businesses – you gain your freedom. Where the value of the shares are driven down too much or rise too much, you have an opportunity to take advantage to further augment your dividend income stream. Finally, the dividend income stocks may be subject to a lower tax rate. This may help create an advantage for investing in stocks over other types of investments.

Summary

There is no one foolproof way to become wealthy or to fund your retirement needs. It generally makes sense to diversify your investments. Owning your home and locking in your living cost is a terrific idea. Investing in stocks to develop a liquid pool of tax-preferred income producing investments for meeting your goals is another good idea.

ABOUT THE AUTHOR  Steve Nyvik, BBA, MBA, CIM, CFP, R.F.P. is a Senior Portfolio Manager with Lycos Asset Management Inc. – an independent investment management firm located in downtown Vancouver, BC, Canada. Steve focuses on building income portfolios to meet family retirement needs and provides financial planning so that if ‘life happens to you’, your goals aren’t derailed in the process. He has been in the investing and financial planning profession since 1992. Steve can be reached at 604-288-2083 Ext 2 or toll-free at 1-855-855-9267, or by email at steve@lycosasset.com.