- By Peter Burke
Capital Growth = the increase in value of an asset
Investment Income = the cash flow generated by that asset
- Cash flow comes from interest, dividends, tax refunds etc
- To provide living needs or buy more assets we need cash flow
- Growth in value of an asset can only be used when asset is sold
- Why is it important to differentiate between income and CG?
- If we can focus on income generation and isolate income produced then we are in a far better position to provide such as living needs/expenses without the risk of needing to sell assets at inappropriate times
- Defensive v/s growth assets
- Having a good mix (depending on risk profile and objectives) of less volatile (defensive) and more growth oriented (usually more volatile) assets allows protection during times of market downturns
- We like to keep 3-5 years worth of income needs as defensive back up to allow growth assets room to move up and down without need to sell at “bad times”
- Growth assets such as Aussie shares usually provide good income as well as potential for additional tax refunds (gross income can be very good)
- Dealing with market volatility
- Keeping growth and income segregated allows us to use predictable reliable income as we choose/need and let unpredictable variable capital growth over time be an incidental benefit, to use if/as we choose
- Unit based (one bucket all the same) v/s range of individual investment assets
- The issue with purely unit based investments, especially in draw down phase, is that we can’t control asset choices for sale and no ability to isolate income generation from growth generation
- As noted above a diverse range of investment types can allow predictable income to cover needs whilst allowing growth to happen incidentally over time without fear of market volatility impacting on capacity to “feed yourself”
- WARREN BUFFET Principle – buy when others are terrified (“market lows”) and sell while others are excited (“market highs”)
- The last thing we want/need is to be a forced seller during poor market conditions.
- Ideally we accumulate income to meet core costs and possibly allow opportunity buying
- Capital growth release during healthy market conditions can allow choice to use elsewhere (possible opportunities) or chose to use realized growth for such as lump sum wishes/needs.
GENERAL PRINCIPLE BBFP APPLY
Income from investments is largely predictable and rational within a small tolerance over reasonable time frames.
Capital Growth on these same investments is very unpredictable and irrational and can rapidly alter.
So, by delineating between income and growth and keeping these proceeds separate, we can manage living costs without the risk of using assets to fund costs at times of market downturns.
Keeping cash flow segregated, to fund living needs, expenses and potential new purchases means market movements, should have little or no impact on timing of drawings.
This blog contains information that is general in nature. It does not take into account the objectives,
financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.
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PB Financial Solutions Pty Ltd ABN 67 097 381 523 – trading as Burke Britton Financial Partners & Securelife Financial Solutions is an authorised representative and credit representative of AMP Financial Planning Pty Limited, Australian Financial Services Licensee and Australian Credit Licensee.