What is Capital Appreciation?
Capital appreciation refers to the increase in the price or value of assets since their date of purchase. Put simply, it is the difference between the purchase price (cost basis) and market price (current price) of an investment.
For example, an investor buys 100 shares of a stock at $50, for the cost of $5,000. If that stock rises in price to $75, he/she would have a 50% return ($2,500 profit) from capital appreciation.
In addition to stocks, the capital appreciation investment strategy is used in a variety of assets, such as exchange traded funds (ETFs), mutual funds, commodities, real estate, and collectibles. When such assets are sold, the profit is called a capital gain.
Why Investors Utilize a Capital Appreciation Strategy?
When successful, a capital appreciation strategy allows investors to benefit from above-average market returns. For example, since 2006, one of the best performing capital appreciation mutual funds had an average annualized return of 14.52% compared to the 10.89% return of the S&P 500. At first glance that might not seem like a big difference but if you invested $100,000 in the capital appreciation fund, it would be worth $764,223, versus $471,396 if you invested the S&P 500.
Capital Appreciation vs. Income Investing
The objective for the capital appreciation strategy is to invest in assets with the expectation they will increase in value. This strategy has a high growth objective and therefore assumes a higher level of risk.
Due to this increased risk, younger investors often adopt the capital appreciation strategy. Younger investors have jobs and earn salaries to pay for their day-to-day expenses. Therefore, they can tolerate more investment risk in hopes of producing outsized returns.
Older investors, especially those that are retired, tend to shy away from the capital appreciation strategy and instead focus on income investing. That’s because retirees are more risk averse. They no longer receive paychecks from their employers and are reliant on the capital they’ve saved throughout the years to generate income.
Income investing is an investment strategy that is centered on building a portfolio that generates a regular, dependable stream of income, which is paid out as a result of owning an asset. This income can be in the form of dividends, bond yields, rent, and interest payments.
However, it’s important to note capital appreciation and income investing aren’t exclusive to younger and older investors. People of all ages diversify their portfolios to incorporate both strategies. For example, there are growth stocks that pay dividends and the value of rental properties appreciates over time. Therefore, when choosing between these strategies, investors must decide what their risk tolerance is, what their investment goals are, and what their time horizon is.
PROS and CONS for Capital Appreciation Investing
PROS
- Capital appreciation investments funds have historically beat the S&P-500
- A long-term approach benefits from deferred tax liabilities, with an investor only taxed when they realize the gain
CONS
- Investments are generally higher risk with a weighting towards growth, which can lead to higher volatility
- There is no guarantee of returns compared to income-generating investments, which is why a longer time horizon is important
How To Invest In Capital Appreciation
The key to outperformance using a capital appreciation strategy is rigorous analysis, research, and diversification. Therefore, a great way to benefit from capital appreciation strategies from stocks is through the use of ETFs or mutual funds focused on this approach. For other assets, it’s recommended to seek out advice from trusted and experienced advisors. A simple search on Magnifi indicates numerous ways for investors to access capital appreciation strategies.
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The information and data are as of the September 7, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
