If one were to buy a share for R100 and sell it six months later for R150, you made a 50% return on your capital over a short period. This is known as a capital gain.
You would be naïve to believe that SARS doesn’t want its piece of the action, but tax is an area that I don’t want to delve into in this article.
The point however, is that if you think this is the only way to make money from investing, you have essentially limited your investment universe to a handful of assets that are 100% capital in nature.
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Over time people have become more aware of the concept of total return. It is an important concept to get your head around. Total return in essence is the theory that it does not matter what form the return comes in, as long as the end investor has achieved the necessary return on investment.
This may seem a little confusing, but let’s consider some other forms of return. First, let us go back to the example of owning a share. This is a small piece of a company.
You imagine your return coming from the value of that company increasing and therefore the share that you own increasing in value as well. This is all well and good, but what about a large company like SABMiller.
It is a huge multi-national brewing operation that does not grow its business at the double digit rates it used to when it was growing into the business it is today. It does however, pay a large annual dividend to shareholders, which is essentially a distribution of the profits to the owners of the business.
Dividend investing has become a fairly popular strategy. The reason for this is that dividends are generally fairly stable over time because a company is loath to cut its dividend due to the negative impression this would give of its future earnings prospects.
Back to the concept of total return. In this case you have two sources of return on a dividend paying stock. The prominent one is the dividend that you should receive from the company which in South Africa is generally between 3% to 5% per annum.
On top of that you still own the share in the company which can appreciate or depreciate in value over time. This means your total return for a given year will be the sum of the dividend yield and the capital gain on the stock.
Sources of Return
The same concept applies to property, although let us think of this slightly differently. Again most people think of return on property as the capital gain from owning it, while it appreciates over time. Forget about the home you own and think about the office block down the road. That office is filled with a tenant who pays a monthly rental.
That rental contract includes an annual increase which is normally slightly above inflation. As the property owner you get a yield on your investment. In South Africa that is around 6% to 9% per annum, depending on the type of property and the quality of the property and tenant.
Now of course the property has a capital value as well, which may be realised if you were to sell the property. However, your return comes in the form of income received from tenants of the property.
Property funds are portfolios of properties valued on the overall value of the properties they own and the estimated future cash flows the properties will generate, so by owning a share of such a fund you essentially would realise both capital gains and distributions of earnings which would make up your return over time.
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There are also bonds to consider as an investment class, where you lend money to a company in return for a predetermined repayment of your capital over time. The amount of return you receive depends on the risk factors related to the entity/government you are lending the money to and also the interest rate environment.
There is more to it than this but at a basic level you may, for example, buy a retail savings bond from the government which should give you 8% per annum over five years. This is an income return and you are taxed on it accordingly.
There are multiple forms of return. They are of equal importance because tax aside, they are as valuable to the end investor. If your investment goal is 10% per annum, it should not matter if it comes as 5% capital gain + 3% dividend income + 2% interest income.
The end goal was achieved and having more than one source of return is probably advisable, as it reduces the risk that a bad year means a negative return.