In the world of investing, building a diversified portfolio is crucial for long-term financial success. While there are various investment options available, equities, also known as stocks, stand out as a powerful asset class that has the potential to propel your portfolio to new heights. Many people avoid investing in equities because they dislike seeing the value of their investments decrease when they review their financial statements. They are not aware that they are missing out on a lot of returns. In this article, we will explore the reasons why equities are indispensable for achieving your long-term investment goals.

"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas." - Paul Samuelson

What are the Characteristics of Equities?

Potential for Long-Term Growth: Equities have a proven track record of delivering substantial returns over extended periods. Historically, the stock market has outperformed other asset classes, such as bonds, cash, or even gold. While past performance is not indicative of future results, equities have consistently shown the potential to generate substantial wealth over the long run. The below graph shows the performance of these assets over 93 years and taking into account inflation (real return)

Source: Old Mutual

Ownership Stake in Companies: When you invest in equities or stocks, you become a partial owner of the companies you invest in. Most day traders and newcomers to the world of stocks think it's just something that goes up and down, like in the movies. Your ownership of your stock entitles you to a share of the company's profits and growth. As the company expands and increases its profitability, the value of your equities can appreciate significantly. 

Dividend Income: Equities can also provide investors with a regular stream of income through dividends. Dividends are a portion of a company's profits distributed to shareholders as a reward for owning their stock. Many well-established companies with stable earnings histories offer attractive dividend yields, allowing investors to enjoy both capital appreciation and recurring income. Dividends can play a vital role in building a consistent income stream during retirement or achieving financial independence.

Inflation Hedge: Equities have historically acted as a reliable hedge against inflation. As can be seen in the first graph, equities tend to outperform inflation much more than other asset classes, this is mainly due to equities having the potential to increase in value as companies adjust prices to offset rising costs. By investing in equities, you can help safeguard your investments against the erosive effects of inflation, preserving your purchasing power in the long run.

Diversification and Risk Management: One of the key tenets of successful investing is diversification. By including equities in your portfolio or investing in an equity index, you can spread your investment across different companies, sectors, and regions, thereby mitigating risk. While equities can be subject to short-term volatility, a well-diversified portfolio or index fund can help reduce the impact of any individual stock's performance on your overall investment.

The graph below shows that in the short term, there will be volatility but in the long term, 5 years and more there's never been a negative rolling return for US equities longer than 5 years. This proves that investing in equities for the long run is a safer bet. 

Source: Old Mutual 

Liquidity and Accessibility: Equities offer high liquidity, meaning you can easily convert your holdings into cash. Unlike other investments like real estate or private equity, where selling can be time-consuming and costly, equities can be bought and sold on public exchanges with relative ease. This liquidity provides flexibility, allowing you to adjust your portfolio quickly in response to changing market conditions or personal financial needs.

How much Equities Should you Have in Your Portfolio

Some people are more conservative investors than others, but the rule of 120 provides a guideline for what your equities exposure should be in your portfolio. You simply take 120 minus your age, to get your equity exposure. Quick example: John is 35, he calculates 120 - 35 = 85 hence 85% of John's portfolio should be invested in equities. Having less than this can lead to you not achieving your investment goals.

Summary

Equities play a vital role in achieving long-term investment goals by offering the potential for substantial growth, ownership in successful companies, dividend income, protection against inflation, risk management through diversification, and high liquidity. While equities come with inherent risks, prudent investing, patience, and a long-term perspective can help mitigate these risks. By including equities as per the rule of 120 guidelines in your investment portfolio, you position yourself to benefit from the wealth-building potential that the stock market has historically provided.

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