Companies often issue shares to raise capital for operational and strategic reasons. Shares of public companies trade on regulated stock exchanges, where investors can place buy and sell orders. Shares are an integral part of the economy because they are a core component of most investment portfolios. Investors can own shares directly or indirectly through mutual funds.
Household Net Worth
A significant portion of household net worth is linked to the market value of stocks and mutual funds, and this creates a wealth effect. During bull markets, people feel wealthier and businesses feel more confident. They spend and invest, which benefits the overall economy in terms of increased employment, sales and corporate profits.
Conversely, during falling markets, individuals feel less wealthy and slow down their spending. This affects business confidence and individual spending, which can drive down stock prices.
Financial Planning and Investment
Capital appreciation and dividend income are two reasons why shares are important to financial planning. A typical balanced investment portfolio contains stocks, bonds and cash. Conservative investors may favor bonds over stocks, while aggressive investors might favor stocks.
Shares are often a source of regular income because some companies distribute quarterly dividends from their after-tax net income. In tax-sheltered investment portfolios, such as 401(k) plans, the capital gains from stock trades and dividend distributions accumulate tax-free until they are withdrawn.
Potential Business Influence
Shareholders have the right to participate and vote in annual general meetings. Small individual shareholders holding a few hundred shares may not be able to influence companies. However, when these small investors join with mutual funds and other institutional shareholders, they can influence corporate boards and senior management to change strategic direction.
Investors can influence corporate strategy by simply abandoning the shares of under-performing companies, thus driving share prices down and forcing the board to make the necessary changes. Healthy companies mean a healthy company, which benefits everybody.
Tax Benefits for Capital Gains
Net capital gains – long-term capital gains minus short- and long-term capital losses – are taxed at a lower rate than regular income. Shares held for more than a year are long-term, while shares held for less than a year are short-term. The holding period starts from the day after a share purchase to the day the share is sold.
As of 2019, the IRS has established three possible tax rates for long-term capital gains, based on your income and filing status, although there is some overlapping between tax brackets. For individuals, you pay no capital gains taxes with $38,600 or less in total income, while you pay 15 percent for income between $38,600 and $425,800. The highest earners making more than $425,800 pay the top 20 percent capital gains tax rate.
Short-term capital gains, however, are taxed as ordinary income, using your marginal tax rate.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.