The equity asset class is a group of investments where you invest in business assets, purchasing equity in the business. You share in the ownership and participate in both the risks and the rewards of the business. You are an owner-investor.
You can select from a range of asset class instruments:
- Common shares, with or without dividends
- Preferred shares, with or without a repurchase option
- Qualifying small business corporation (SBC) shares
Your employer may grant you one or more types of long-term incentives (such as, stock options) that provide an opportunity to benefit financially if the share price increases over a fixed period of time.
Many factors may affect the price of equities including:
- Internal factors, such as the profitability, size and financial stability of the company
- External factors, such as technological change and environmental impacts
- Economic conditions, such as changes in interest rates and the business cycle
- Investor sentiment
SBC shares may be eligible for all or part of the lifetime capital gains exemption (LCGE) when sold. The exemption was $883,384 in 2020 and is indexed to inflation in subsequent tax years. The limit for SBC shares in 2021 is $892,218.
Risk and Return: The Test of Time
Risk and return have varied through time. Check out the comparison of annual returns and the growth of $100, as illustrated in the All-Equity Portfolio slideshow that follows. As you review that, notice the following:
- The annual returns (bar graph):
- It's normal behaviour for equities to produce a negative year-over-year return every few years. As an investor, you only lose money if you sell.
- It's normal for equities to produce higher highs and lower lows than fixed-income investments.
- The equity returns are diversified (one-third each from Canada, U.S. and International markets). Expect higher volatility from returns of a single country.
- The growth of $100 (blue line graph):
- The growth of $100 is not a smooth upward line. Investors have to stay invested through market ups and downs to achieve similar results.
- An investor's personal growth of $100 is influenced by when the investor started and stopped investing.
- A better result: start in a market low and end in a market high.
- A worse result: start in a market high and end in a market low.
Observe how this all-equity portfolio has faired over the long-term. Click the button below to start.
Compare equities (stocks) to fixed income: Proof Is in the Pictures: Risk and Return Over Time
Description of Investments
Descriptions of the various types of equity investment instruments are shown below. The investments are listed in order of risk, starting with the safest and ending with the riskiest, most speculative investments.
Retractable preferred shares (May also be placed into the fixed income asset class)
- Represent ownership in a corporation, which is senior to ownership through common shares
- Superior claim on assets (ahead of common shares) if the corporation is dissolved
- Issued with a known retraction date, when the original investment can be recovered
- Marketable prior to the retraction date, usually at a price similar to the issue price
- Pay a fixed rate of dividend, which comes from after-tax profits of the corporation and has priority over dividends on common shares
- Subject to solvency of the corporation for payments of dividends and retraction price
Preferred shares (non-retractable)
- Same as for retractable preferred shares, except that the corporation does not retract the shares
- Value fluctuates more than that of retractable preferred shares
- May be convertible, into common shares, under certain conditions
- Represent ownership in a corporation
- Shareholders have the last claim on assets if the corporation is dissolved
- Risk varies depending on the success of the company
- Price fluctuates constantly
- Larger corporations pay dividends, dependent on the corporation’s earnings
Qualifying small business corporate (SBC) shares
- Features are the same as for common shares
- Lifetime capital gain exemption (LCGE) may be applied
- Borrowing to purchase shares and deducting interest paid will create a cumulative net investment loss (CNIL) account balance, which must be eliminated before applying the LCGE
Employee long-term incentives (LTIs)
(Employee stock options, employee share appreciation rights [SARS], employee tandem share appreciation rights [TSARs], employee restricted or performance share units [RSUs and PSUs])
- A form of deferred compensation
- Employer grants a future right to purchase or benefit from a price increase in company shares at no initial cost to the employee
- Eligibility, price and expiry dates are outlined at the time of the award
- Employees have none of their own money at risk; they either benefit if the share price increases or receive nothing if it does not
- RSUs and PSUs are linked to company performance; they may pay out in cash or in shares
- Share option gain is similar to capital gain and taxed at a 50% (75% for Québec tax) inclusion rate while profits from other LTIs may be added to other income and fully taxed
TMX Capital Markets Learning Centre