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Investment Basics:  How to Own Stock Thumbnail

Investment Basics: How to Own Stock

By Danielle Woods

Personal finance can be one complicated mess with constantly changing market conditions, legal updates, and life activities. Coupled with 24/7 headlines, sales pitches, and unsolicited advice, you may find yourself fixating on the issues that you cannot control. 

At times like that, we recommend pushing aside the noise and getting back to basics.  The purpose of this blogpost is to educate new investors and to remind seasoned investors about what they really own in their investment portfolios:  equities.

The word “Equity” means a few different things in the English language, but for the purposes of this blogpost, we are referring to an asset type.  An equity represents an ownership interest in a company or in another type of asset that owns companies, like a mutual fund.  Some investors think this just means “stocks,” but it’s more detailed than that.

Our Propel team recently enjoyed some time altogether in the same city, and we recorded a podcast about this topic.  You can watch and listen to our conversation here: Adventures in Asset Selection 

Three Types of Equity Assets

There are three types of equity assets that we invest in for our clients:  mutual funds, ETFs (Exchange-Traded Funds), and individual stocks.

Mutual funds and ETFs are often thought of as very similar, and they are in one important way:  they are both run by a fund manager who chooses companies that will be included in the fund.  How those companies are chosen vary greatly depending on the goal and criteria of the fund.

David Vaught, CFA, stated in our podcast that he likes mutual funds because “they are flexible, they’ve been around awhile, and they are managed by a professional.”  Mutual funds allow you to own a lot of companies. You can buy a mutual fund for as little as $10 or $20. It’s a great way to get started with investing.  

ETFs are newer asset types, and they are a lot like mutual funds in that they are managed by a professional and allow a person, even with a small amount of money, to own shares in a lot of companies.The owner of an ETF share, however, has an ownership interest in the underlying companies.  That is not the case in a mutual fund.  You simply own a share of the mutual fund. On the podcast, I used the example of a candy bar:  With a mutual fund, you own a piece of the wrapper, but with an ETF, you own a piece of the candy bar.

Our teammate, Amanda Vaught, pointed out that mutual funds are less transparent than ETFs because the day-to-day activity is not obvious.  An investor in a mutual fund will not know except for once per quarter, what positions are in the fund. An ETF can be monitored regularly.

The last equity asset type we buy for you are individual stocks.  In this situation, you own a piece of the company and pay no 3rd party fund manager (outside of your Propel advisory fee).  

Buying and Selling Equity Assets

When it comes to buying or selling a mutual fund or ETF, they are quite different.  Mutual funds have a closing price that is determined at the end of each market day.  Every investor, whether they submit a purchase or sale in the morning or the afternoon, gets the same price.  

ETF’s, on the other hand, trade like stocks.  Both ETF’s and stock prices change constantly throughout the day.  You will get the price at the moment you submit a trade, unless you limit your order to a specific price (called a limit order).

They also “close” differently.  It takes just 1 day for a mutual fund trade to be completed.  If you enter a sale on Thursday, the cash proceeds will be available on Friday morning.  ETF and stock trades take two days to close.  If you sell a stock on Thursday, the cash will settle on Monday.

Tax Considerations

Something we did not delve into much on the podcast was tax considerations of owning equity assets in a taxable brokerage account.  A taxable brokerage account is pretty much any account that is not a retirement account (IRA, 401(k), Roth IRA, 457 plan, 403(b)) or a college savings account (529 plan, Education Savings IRA).  

While you own them, all three types of equity assets could be producing taxable income in the form of dividends or, in the case of mutual funds, capital gains distributions.

Dividends are payouts of profit from the company or companies that you invest in.  Dividends are either qualified or nonqualified.  Investopedia offers a detailed article about Qualified dividends if you’d like to read it.  The gist is that stock shares “that pay dividends must be held for at least 61 days within a 121 day period that begins 60 days before the ex-dividend date [the period of time in which a shareholder qualifies for the current announced dividend rate]” in order to be Qualified for tax purposes.  What Are Qualified Dividends, and How Are They Taxed? (investopedia.com).

Qualified dividend tax rates are often more favorable than unqualified dividend tax rates.  A taxpayer will pay federal tax of between 0% and 20% on a qualified dividend depending on their Adjusted Gross Income (AGI) for that tax year, just like capital gains.  Nonqualified dividends are taxed like regular income and could be taxed as high as 37%, dependent upon the taxpayer’s AGI that year.  

Mutual funds pay out capital gains as well because they hold onto the gains in a fund until the very end of the year.  Those capital gains are subject to federal income tax rates between 0 & 20% depending on the taxpayer’s AGI.

It is worth noting that you do not have to distribute the cash proceeds from your brokerage account in order to be taxed.  Many investors simply reinvest the dividends and capital gains upon receipt.  You will still pay the tax on it, but those amounts will not be taxable later.  

Basically, the longer you hold an asset, the better the chance you have of paying capital gains rates instead of regular income tax rates on your taxable equity asset income.

The Allocation Decision

Now that you know about each type of equity asset, how do you decide what to invest in?  

While it’s true that there are literally thousands of options, and you could end up being invested in hundreds of companies, what is the best way to build your portfolio?

Our team is here to help you with that issue.  Listen to our full podcast to get insights about how we individualize your portfolio to address your interests, goals and needs.