This includes your Super account, Pension account, or any investment account you may have.
The normal answer to this question is ‘I can’t lose my money’; that is, safety of capital. But is it only safety of capital? And what makes an investment safe?
It really depends on what the purpose of the investment is. For example, is it capital held in reserve for a ‘rainy day,’ or to meet some future capital payment (a future debt, or tax liability for example)? Or is it to cover present or future regular expenditure, such as retirement living expenses? ie: Is it for a Capital purpose, or an Income purpose?
Capital or Income?
Clearly, if you need to meet a future Capital obligation, the capital has to be there. And if you need a regular Income- stream, you need to know the Income will be there.
In regard to the latter, clearly Capital is of less importance than if you had to meet a capital liability. In other words, the safety you need for your Income-stream is the assurance that your Income-stream will be there come what may.
Of course, you need the capital to fund the income stream, but that’s a relatively simple matter of knowing how much Income you require, and how much capital you initially need to fund that Income.
Sounds obvious? Yes, it is. But it also depends on how the investment generates the Income-stream. Is the income Interest-income (earned on money ‘lent’ to a financial institution), or is it Investment-income (ie profit) earned on some asset you own, such as company shares, or a rental property? (We call this equity investment.)
There is a big, big difference! The difference is that the capital value in the Interest-income investment remains constant (excluding re-invested interest), whereas the capital value of the Investment-income asset will tend to change, even day by day, despite the constancy of the income-stream.
But in a normal, healthy economic environment, the Investment income- stream will tend to increase year-by-year. And as the Investment income increases, so too will the capital value of the investment asset. It must.
What deceives many investors, however, is that the Income-stream and the asset value don’t automatically increase at the same time. The asset value may increase ahead of, or lag behind, the increase in the Income- stream. Sometimes, in fact, the Capital value will decrease, although the Income-stream is increasing.
But if the Income–stream is increasing, and expected to continue increasing, then clearly, falling asset values don’t matter. The assurance of the Income-stream is what matters! And if the Income-stream does increase, and capital values ultimately follow, then we can regard the investment as safe.
This simple concept is the ‘trick’ to understanding share investment (or, as we at Wellinvest prefer to call it – ‘Investment in economic enterprise’).
It is also the secret to having Peace of Mind in regard to your investment capital, and thereby in regard to your whole financial security.
Share prices around the World have declined over the past twelve months (though have recovered somewhat over the past few weeks). However, here in Australia particularly, our economy continues to prosper and grow. Income from most of Australia’s major companies in 2008 is expected to exceed its 2007 levels. Does this suggest that shareholders in these companies have a safe investment? Even though their share prices are currently lower than they were a year ago?
Let us, however, recognise that this is not the lesson taught by much of the media, nor even by the investment industry itself. As we have said many times previously “It’s not about the All Ords.”
Footnote: Many investors do invest essentially for Capital Profits, and pay scant attention to Income generation. This however is gambling – it’s speculation – no matter how calculated, or how ‘systematic’. And gamblers don’t usually win. There is no need to gamble with your Capital; it can be safely (and very profitably) invested by understanding the above guidelines.