As the equity investment market in Canada is in strong decline as of late I am doing a few posts on investing concepts.  I strongly recommend you follow the series in sequence.  I started yesterday with some high level concepts.

Disappearing Value

In the case of equity investments you are actually purchasing a piece of paper, that is a stock certificate; which indicates how many stock you purchased and that they are registered to you.  (In today’s world your broker usually keeps the registration record on your behalf  electronically and actual certificates are not issued. The stock is technically shown on the company books as held by the “street name” of the broker.   You are known as the beneficial owner.)

The point is, when you buy the stock what you are actually buying is a piece of paper  (or electronic record) saying you have some ownership on the issuing company.

As an owner you are entitled to dividends (a fixed amount returned to the owners on a fixed frequency) if the company’s board of directors decides to pay them (they don’t have to).

If the demand for the stock rises and others want to buy it you can sell your piece of paper for more than you paid for it.  The difference between what you paid and what you received is a capital gain.

If the demand drops, but you need to sell your stock (piece of paper) and get the money out for other purposes you might sell it for less than you paid.  The difference between what you paid and what you received is a capital loss.

Unrealized Capital Losses and Gains

The stock market your stock is listed on (for example Toronto Stock Exchange) will list the offered buy and sell prices throughout the business day as well as actual buy and sell transactions that occurred.  You can use the offered selling price or the actual end of day closing sale price to determine if your stock is worth more or less than you paid.  Until you actually sell your stock this difference is called an unrealized loss or gain.

Focus on Income or Capital Gains?

If the stock is paying a dividend and you don’t need the capital (what you originally paid for it) for other purposes  the unrealized loss or gain is irrelevant.  The income keeps rolling in (unless the board votes to stop paying a dividend)

NOTE: Some equity investments can pay the income in interest rather than dividends – more details on why it is interest rather than a dividend will be in future blogs)

If however you bought a stock which does not pay dividend or interest income because you were planning to make a profit by realizing capital gains the current state of the market where thedemand for stock is dropping, your situation is more tricky.

So the capital value of your investment might be vanishing, and it might not matter due to the fixed income or if you need the capital and have to sell that is not good, a loss will be realized.

Mostly equity investors combine capital and income to achieve overall gains but leaning toward one approach over the other can be more appealing to an investor depending on their objectives and risk appetite.

More on this topic tomorrow.