Deciphering your Investment Returns: Income vs Capital Growth
What is an Investment a return? Simply put, returns are the profit that you earn from your investments.
In my last article titled “How to integrate property into your investment portfolio for the New Year”, I suggested that we could look more closely into deciphering which investment returns would suit your lifestyle best: Income Based Investment Returns or Capital Growth Investment Returns. The terminology often used for these, regarding Investment structures are ‘income focused’ and ‘growth focused’. Do note that some investments can give you both income and growth focussed returns, however, it is important to distinguish between the two, for a sound understanding and better investment acumen.
Income focused funds will deliver an investor monthly earnings, while a growth fund is focused on increasing the original sum invested as much as possible, or by a set amount, within a certain time frame. As with many investment types, property investment can generate either or both income focused and growth focused outcomes, depending on where and how you invest your money.
This type of property investment is bought with the foremost intention of earning an income stream from it. It can be a very lucrative way to invest, when managed well. The area of focus with this type of investment is to pay attention to the yield that it offers which is the regular financial return to be expected.
As a stand-alone landlord, Rental yield can be best described as, what your tenant/s pay in rent, minus any maintenance, running costs, repairs, agents’ fees, taxes etc. This yield in no way affects the original investment sum, however, it does indeed reward your investment efforts.
As a shareholder, Dividend yield is best described as the distribution of reward from a portion of your property investment’s earnings, paid to the shareholders as per agreement, which is calculated as: Dividend Yield = Annual Dividend / Share Percentage.
Whether you are a landlord or a shareholder, you will want to look at your annual return as a percentage, as this will allow you to make better comparisons with other investment products like savings accounts, ISAs, tracker funds which will give you either guaranteed Annual Equivalent Rates (AER) or non-guaranteed or ‘indicative’ dividends.
This type of investment strategy is focused on the growth of the invested capital. This type of investing can only be done with companies whose earnings are expected to grow above the average rate either of the particular industry it is in or compared with the overall market.
Property in the UK, on average, has been on the increase since 2000. Residential property has seen an average growth of 6.6% per annum and commercial property 3.7%, both of which have out-performed inflation rates of 2.8% (Retail Price Index) over the same period. As is very common with property investment, the market can fluctuate significantly and often does, with what the industry calls ‘booms’ (2001-2004 residential) when property prices rise and ‘crashes’ (2007-2008 commercial) when the property prices decline.
It must be noted that no matter which strategy you choose to be right for you, costs are incurred and taxes liable.
How to know which strategy suits you best?
|Income Focused||Growth Focused|
|Smaller personal income||Larger personal income|
|Larger Capital Sum||Smaller Capital Sum|
|Shorter Time-line for Return||Longer Time-line for Return|
|Taxed as Additional Income or Specific Dividend Tax||Taxed as Capital Gains tax|
When deciding on what investment strategy or plan works best for you, always review your personal needs and goals. Take some time to think about what you really need and want from your investments. Not only do you need to know yourself, your needs and goals but your appetite for risk as well.
Think about how soon you will need your money back in real terms. This will affect your investment timelines and investment types.
Make an investment plan, that helps you to diversify. Start with low risk and build up your investment muscles from there. As it is said, to enjoy a better return you need to accept more risk. A diverse investment portfolio will stand you in good stead over the long term and helps to manage and improve the balance between risk and return.