Abstract: Describe the differences of investments between capital gain and fixed income types. In addition, some practical examples are explored to illustrate the importance of capital gains toward long term investments and financial freedom.
Can you tell whether the original intention of your investment is for capital gain or fixed income?
First, I would like to introduce a very basic but important concept on investments, that is about the two different investment directions – capital gain and fixed income. Many people may already know their differences, but few of them really care about it. Let me give you a practical example, many people buy mainland China bank stocks on the purpose of gaining the stock price increase, that is what we meant by capital gain. However, very often after buying those stocks, the Chinese capital-gaining stocks start to drop and the investors once claimed to be the capital gainers now change their point of view fast and said, “It doesn’t matter if these bank stocks continue to drop or not, I’ll be ok with that because they are still providing good dividend payments.” So, you can see that they change their direction passively because of the market. Unfortunately, it turns out that they often lose big finally on the stock price despite of comparatively tiny dividend gains. I believe many people have the same experience on this sort of stories.
Which investment belongs to capital gain types? And fixed income types?
First, capital gain type investments include situations like when you earn the money from the increase of housing price, stock price or gold and bitcoin price. On the other hand, fixed income type investments include collecting property rents, bond coupons and cash distribution from Real estate investment trusts (REITS), and etc. Of course one may claim that he can also earn the capital gain portions from bond and reits, but that is simply not the main reason of buying them.
Which investment is more important? Capital gain or fixed income?
Actually, capital gain and fixed income are two very different investment logics. If you cannot distinguish them from one another, it will certainly have big impacts on your investment outcomes. At this point, many may ask which one is then more important – capital gain or fixed income? The simple answer here is that both are very important, though the degree of importance may vary based on different types of people or the same person in different life stages. Capital gain type investments potentially offer higher returns with higher risks while fixed income type ones provide relatively lower risks and less capital fluctuations with higher predicable cash inflow. Therefore, whether capital gain or fixed income is better really depends on each individual’s personal situation, which includes their risk taking abilities or do they need regular cash inflow to maintain their living, etc.
Are the cash flow pursuing approaches always the right ways to invest?
Let me talk about my thought first. I personally disagree with the statement that a good investment should always include cash flow, but I understand that many people may not agree with me. Like many famous investors, the author of Rich Dad series books Robert Kiyosaki said, “Only the investment that generats cash flow is asset, the others are fake assets, or just liabilities.” I would like to use my real case to explain my thoughts. I was born in the 80s and now have quite a stable career (though not passive income), it is not an immediate necessity for me to earn cash flow from my capital at present. In addition, my investment period is planned to be more than 10 years. So in my situation I believe I should be able to bear higher risks. As a result, I have allocated most of my fund on the capital gain type of investment. I sincerely believe that cash flow is important, but in order to acquire cash flow you have to forgo capital gain which I believe the loss of opportunity cost is way too costly for me right now.
Is the long term return of capital gain really higher than that of fixed income?
Many critics claim that the capital gain type investments such as stock and property are way much more volatile than their fixed income counterparts despite higher potential returns. More than that, investors may lose them all when they happen to encounter the bear market. In my point of view, if you are concerning about this sort of risks, you are most likely focusing on the short term situation. However, if we look at a bit longer perspective which is in the medium or long term, we may look back the history the average long-term return of S&P 500 index is about 10% while the fixed income returns like the US corporate bond and some larger reits is about 4 to 5%, say 5%. (I understand some people would say the return in the future may not always be the same as in the past. But if you do not believe we will have a better future, you should not invest anymore and there are no needs to further discuss.) Use an example to demonstrate it, if you want to double your initial fund, you will need about 14 years in case of 5% annual return but only 7.5 years in case of 10% return per annum. You can see such a huge difference here and you can actually save a lot of time in your lifetime. In other words, if you still have a long way to reach your destination of retirement or financial freedom, say 10 or even 30 years, I strongly recommend that you should allocate your capital onto the direction of capital gain and let it work for you for as long time as it can be to swell the amount of your fund significantly or even exponentially. After that, your fruitful financial outcome will be enough for your retirement life, only at that point should you change to allocate your fund on the other runway – fixed income investment.
The importance of capital gain in the pursuit of financial freedom
How much is “enough”? This is the question many may ask and the result varies from people to people. Let’s look at another example, if the total expense of a family is HK$50k (For the sake of simplicity, inflation is omitted here), that is HK$600k a year. In order to earn it, you get to need a large sum of principal of HK$12M in case of 5% return annually. Remember, this is the target of this family to mean “enough”. Let’s say the family has only HK$3M today, they need about 14.5 years to reach that goal if 10% annual return rate is maintained on average during this period of time. If you understand that investment is a life long matter, then spending 15 years for investment in return of financial freedom is in fact not unreasonably long. We can see that let the capital gaining investments be able to grow compoundedly is really critical towards financial freedom.
Share what I have learnt out of the past 15 years of investment experience
To be honest, I have been through my investment period for 15 years up to now and if I understood this simple truth before this journey, I utterly believe that I would have done way much better. After I understood these simple truths of investments, I can see that in terms of mentality and practical investment achievements, I have attained much better results than what I tried in the past using every kind of different complicated so-called investment methods. So if you are standing right at the starting point of your investment life just like I was 15 years ago, I sincerely wish I can share my knowledge and experience and all the mistakes I made over the years through this platform with you.
How delay of gratification affects the overall investment results
A very critical concept here is the importance of the delay of gratification. Because only then, the investment fund can work for you really hard on a long enough runway and your wealth can grow compoundedly. Let me illustrate it with some practical numbers, can you guess what is the percentage gain will you get after 30 years with 10% annual return? The answer is the astonished 1700%, or 17 times. That is if you have HK$3M today as in the above example, you will accumulate about HK$51M after 30 years which should be well enough for the retirement lives for many ordinary people.
Compound interest calculator
This article explained the importance of compound interest on long-term investment success. Now, you may use the “Compound interest calculator” that provided in this website and calculate the results based on your practical situations, including four different situations to obtain: total return, annual average return rate, investment time and principal. Try by yourself now. Hence, you may better plan your long-term investment strategy.
Comments and sharing
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