• Capital growth is the increase in value of an asset over time.
• The difference between the current market value of an asset and its value at the time of acquisition is how capital growth is measured.
• Capital growth-oriented investors tend to have long-term goals and seek to maximize the growth of their investments, rather than generate immediate revenue.
An increase in the value of an asset or an investment over time is considered capital growth. Essentially, it represents the amount by which the current market value of an asset or an investment compares to the purchase price. Capital growth is said to have occurred if the current value of an asset or investment in an investor’s portfolio is greater than its acquisition price.
Here’s why investors should pay attention to capital growth.
Growth vs Income Investing
Generally, investments can be divided into two categories — growth and income. A growth-oriented investor usually has long-term goals and seeks to maximize the growth of their investments, rather than generate immediate revenue.
The income investor is usually operating on a shorter time horizon and has an immediate or near-term need for income. In most cases, the income investor seeks to minimize risk. The growth investor is less risk averse, as they are counting on time to increase the value of their investment.
Moderate Growth vs High Growth
One of the main axioms of investing is that risk and reward tend to go hand-in-hand. The more risk an investor is willing to accept, the greater the potential for reward they can anticipate in exchange. Thus, a high-growth investment strategy is one that entails an elevated risk factor. Meanwhile, a moderate-growth investment strategy is one that seeks to minimize risk, while still achieving gains.
In practice, this means the moderate growth investor will likely stick with companies whose stability is proven. These are also referred to as blue-chip investments. On the other hand, an investor seeking high growth will look for speculative opportunities that promise exceptional long-term growth. These companies generally have not been in business long enough to have a strong history of profits or earnings, but exhibit the hallmarks of outstanding earnings potential.
Capital Growth vs Capital Gain
While the two concepts are related, there is one key difference: capital growth is a measure of the increase in value of an investment or an asset, over and above its purchase price. That growth becomes a capital gain when the asset is liquidated.
An investment purchased at $10,000, which experiences 10% growth over its first year, will have a value of $11,000 at the end of that year. The additional $1,000 is considered capital growth if it is reinvested. However, that amount is considered a capital gain if the investor sells the asset and takes the $1,000 as income.
In other words, selling an appreciating investment converts its growth into gain.
The Capital Growth-Oriented Portfolio
In most cases, portfolios pursuing a capital growth strategy will mainly be invested in equities. The specific percentages and amounts will vary according to the investor’s time horizon, financial wherewithal, overall goals and tolerance for risk. A typical capital growth portfolio will be comprised of 60% public stock and 40% fixed income allocations.
This diversification will provide ample opportunity for aggressive growth, while shielding the investor from significant loss if the high-growth investments perform in a less than optimal fashion. In many cases, the high growth investor is younger and focused on saving for retirement or other long-term objectives such as funding a new child’s college education.
A younger investor is also likely to have the time to weather potential downturns on their way to their goal. This is less true for someone for whom retirement is imminent. Because of this, the latter group is more likely to focus on capital preservation than growth, as the income from their investments will play a greater role in maintaining their lifestyle.
Alternative Investments, Growth and Diversification
Alternative investments can be useful tools for portfolio diversification. This is generally agreed to be a smart investment strategy to pursue. Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. They also present opportunities for capital growth.
As mentioned above, traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
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Capital Growth and Investors
Investors should pay attention to capital growth because the type of capital growth they pursue should be a determining factor in the investment strategy they employ. Investors with a longer time horizon can afford to engage a portfolio with an asset allocation more heavily reliant upon high-growth opportunities. Investors nearing the age of retirement, or those with more immediate financial needs, are likely to be better served with a strategy that’s more attuned to capital preservation.
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