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The basic ins and outs of investing in a business

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This article on investing may start out seeming basic and fundamental, but in Part 2 coming up, it will provide some thought-provoking insights to challenge both investors and advisers.

How's that for a promise? We'll try to deliver.

When you buy a company -- let's pretend you buy the whole thing -- you expect to get a return on your money. You may be paid a salary if you work in the business, or maybe just a share of the profits. You also hope you will be able to make the company grow, improve its customer base, increase profits and eventually sell for a profit.

When you buy a whole company, you may also have to manage it, worry personally about employees and customers, and maybe even worry about employing family members or passing the business on to them in the future. To sell down the road, you must find a buyer and negotiate the sale, the price and the terms.

Buying part of a business -- buying stocks or shares

To solve some of these issues, and to provide capital for a business to expand more quickly, the public market -- the stock exchange -- was created. It is a "place" where willing buyers and sellers of company shares come together, bid for shares, ask for a certain price, and trade, through investment dealer intermediaries.

Your purpose as an investor in participating in this market is to be able to buy shares in companies that you think are well-managed, have strong balance sheets, are growing their earnings and have a particular niche or advantage in their business area.

You are able to buy the amount of shares appropriate to your situation, and don't have to buy the whole company. You can, therefore, buy shares of several companies, to diversify your eggs into several baskets.

As a shareholder in a public company, you have equity, but do not have to worry much about management or succession issues. Selling is seldom a problem, as most exchange-listed companies trade millions of shares every day, ensuring liquidity. You can sell when you want, if you are willing to accept the price that is bid at that time. Or, you can hold out for a better bid.

Your purpose in equity investing is to seek a return on your money, through dividends and/or capital gains.

Tax treatment

Many mature companies pay dividends. These are a cash payment (or occasionally more stock) paid to shareholders, usually paid every three months. Large companies have already paid corporate tax at a high rate, and so they are able to pay "eligible" dividends to shareholders. Eligible dividends are taxable, but also attract a large dividend tax credit to offset some, or even all, of the tax on the dividend.

For taxpayers with less than $41,000 of taxable income, the tax rate on dividends is either negative 2.3 per cent or just 2.47 per cent, in Manitoba. A pretty good deal, and it reflects the fact that the company already paid tax on the same earnings at a high rate.

For higher-income earners, the tax rate on dividends is 10.31 per cent, on taxable incomes up to $67,000, to a maximum of 26.74 per cent in the top bracket. Some shareholders choose a dividend reinvestment plan (DRIP) to reinvest their dividends automatically in more shares. The dividend is still taxable, but this is a great growth technique.

Capital gains are only reported when the gain is realized, when the shares are sold or there is a "deemed disposition." So, you can buy a share for $10, and hold it for 20 years, during which time it might grow to be worth $40, and you will have paid no tax on that growth until you sell or dispose of it.

Join us here next Friday to talk about investing in mutual funds and ETFs, plus wise observations about the dynamics of the stock market, how to invest more successfully and a story about some real-life conservative investors who have had all of their money in stocks for the last 15 years, and are happy with their results.

-- -- --

Huge kudos to the financial services community in Winnipeg, to Winn$tock 2012 co-chairwoman Cindy Reid and Yvonne Burman, and all of the other volunteers and musicians. Last week they produced a fabulous night of great music, and raised $55,000 for Manitoba Riding for the Disabled and the Manitoba Brain Injury Association.

Celebrity judges Howard Mandshein of 92 CITI FM, Brad Oswald of the Free Press and Kenny Shields of Streetheart wisely named Prime Plus One as champions this year. Congratulations to Kevin Tillberg of Credential, Trent Simpson of Entegra and Shaun Proutt of Birchwood Credit Union, along with "ringer" Rick Yarish. Fan faves were the Bailouts.

David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).

Republished from the Winnipeg Free Press print edition March 23, 2012 B16

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