How Investments Really Work - part 1
We invest so that our money can go to work while we live the good life.
Investments can offer us three things:
Capital protection = little chance of losing money, or low downside risk
Income = interest or dividends or rental income that are the fruits that flow to you
Capital growth = real growth in the underlying value of the investment that exceeds inflation
Here are some common investment types and how they stack up:
Cash – you get a lot of capital protection, because the amount in your bank account today is the same as tomorrow. And a little bit of income in the form of interest. But no capital growth opportunity.
Bonds a.k.a. fixed income investments or treasuries – have some capital protection, because there is an ultimate promise to repay the loan. They earn interest at a slightly higher rate than cash. But again there is no capital growth opportunity.
Property, is the only asset class that has displayed all three of these characteristics. It tends to have some element of capital protection because there are underlying physical buildings. It earns rental income and unlike interest on bonds or cash, the rental income stream can usually grow with inflation. The underlying buildings and thus the listed property shares also have the potential to increase in value, so it can have capital appreciation.
You don’t have to be a landlord to be a property investor, there are commercial property funds you can invest in who own things like shopping malls or big developments/
Equities are the other extreme from cash – no downside capital protection, but the opportunity for capital growth is high. Equities do also earn income in the form of dividends which typically grow with or ahead of inflation.
Next in this series, we’ll cover how to know what the right investments are for where you’re at.