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Investing: It’s not “Chicken or the egg”, it’s “A horse and cart”

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If you’ve ever read or listened to media pertaining to the finance Industry you may have come across the term ‘capital growth’.  Certainly we as financial planners love nothing more than to talk it up in every way imaginable.  But have you ever considered why the value of assets like shares go up and down over time (think Global Financial Crisis)?

Capital growth (or loss) is a by-product of a company’s current and expected profit.  What does that mean?  Well, think of capital growth as the ‘cart’ and income as the ‘horse’ because as we know the horse always comes before the cart.

Think about this, you are looking to buy a small business, in establishing a fair price to pay for this business the primary driver is how much profit it makes, or it’s expected to make.  So whilst in the short term fear and greed can certainly play a part in a company’s share price, eventually common sense will prevail and the share price will follow the profit of the business.

And here is the good news:  Whilst share prices are volatile (thanks fear and greed responses) the income (i.e. dividends) by comparison, is very stable.  Let’s take the Commonwealth Bank of Australia as an example:

CBA-share-price-example

Remember its income that will buy airline tickets in retirement, not capital growth.  So don’t worry so much about what your investment or superannuation portfolio is worth, spend your energy on how much income your portfolio is paying you and is expected to pay you in the future.  After all, it means less stress and less financial uncertainty, and that’s what good financial advice is all about.

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