While safety, managing investment risk to protect a portfolio from loss, is probably the most important aspect of asset management, growth of capital and cash flow also play an important role. Different types of assets have different levels of average returns, and, in general, high returns equate to high risk. So, investors must take into consideration how safe they want their investments to be while balancing the return on investment they would like to receive.

 

Managing Rate of Return on Investments

Rates of return on investments are generally considered to come in two categories: growth and cash flow.

 

Investing for Growth

Some assets have growth but no cash flow – for example, a biotech stock that increases in value by 20% in a year but pays no dividend would provide growth, but no cash flow. An investor who owned it would be 20% richer at the end of the year but have no cash in their pocket.

 

Investing for Growth and Cash Flow

Some assets offer both cash flow and growth, in varying degrees. The more of one they have, the less of the other. Growth-focused assets would be expected to have higher average returns than income-focused ones, and also have higher risk.

The S&P 500 index fund SPY, for example, has a long-term average total rate of return of about 10%. This is made up of, on average, about a 7% increase in value and 3% in dividends. In recent years, it has skewed more like 8% growth and 2% dividends.

The Utilities ETF, called XLU, has had about a 7.2% average total return over its 20-year lifetime to date. This has been split almost exactly half and half between price growth and dividends.

 

Investing for Cash Flow

Some assets have cash flow, but no growth.

For example, the exchange-traded fund called PFF is a collection of dividend-paying preferred stocks. It closed at $37.15 per share today. Eleven years ago, in July 2008, it was at exactly the same price, $37.15. It has had zero growth in value in eleven years. We should note that that does not mean that the price has never budged. In fact, over that period the share price has ranged from $50 a share at inception, down to $14 in the financial crisis, and back up to $37 now. Through thick and thin, it has continued to pay its dividends, paying out $29.74 per share in total dividends. Its net annual return for its diehard buy-and-holders has averaged 5.5%, all of it in the form of cash dividends.

A similar example is the REIT called AGNC. Since its inception in April 2008, AGNC’s share price has dropped from $19.50 to $16.82, touching a high of over $36 and a low of $12 along the way. But for all that time, it paid high dividends, for a long-term average rate of return of over 10% per year, after considering the drop in the share price. At current prices it was recently yielding over 11% annually.

 

Dividend vs. Non-dividend Stock

As an economist and accountant, my point of view is that the separation of growth and income, common among investment advisors, is not really valid. Cash flow that is reinvested becomes growth of principal, while growth of principal that is partially harvested becomes cash flow.

If I start with stock worth $100,000, and the stock pays dividends of $5,000, and at the end of the year the stock is still worth $100,000, I’ve had a 5% increase in my net worth. $100,000 in stock plus $5,000 in cash from the dividends equals $105,000, a 5% increase.

On the other hand, if I start with a different stock worth $100,000, and the stock pays no dividends, but at the end of the year the stock is worth $105,000, I’ve had a 5% increase in my net worth. $105,000 in stock is a 5% increase. If I want that 5% in cash, I can sell $5,000 worth of shares and end up with $100,000 in stock and $5,000 in cash, identical to the other case.

This equivalence, by the way, is why dividends are not taxed as ordinary income. They are taxed at capital gains rates (unless the dividends are from REITS, which pay no corporate income tax. Their dividends are taxed at ordinary income rates.)

For some investors, the two example investments above are not equally attractive. For example, if know that I need to withdraw and spend the $5,000 every year, rather than letting it accumulate, then I am better off with the dividend-paying stock. Although its return is the same in the long run, in the short run I want to know that the cash is coming in, without relying on selling shares that might or might not have gone up in a given year.

Someone else, who is many years from retirement and needs no cash flow now, might not want to be bothered with constantly reinvesting small dividend payments. It would make more sense for that person to use the non-dividend stock.

When evaluating investments, consider whether their total return characteristics match your investment goals. Consider whether you prefer skewing your returns toward current cash flow or toward growth of principal. For most people, it will make sense to include a mix of both types.

Read the original article here - Choosing Between Growth Investments and Income Investments

This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions. The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Reproduced by permission from OTAcademy.com click here for Terms of Use: https://www.otacademy.com/about/terms

Education feed

Editors’ Picks

Euro rolling into the Asian session below the 1.1050 level

The shared currency, on the daily chart, is trading in a bear trend below the main DSMAs. The Euro has been in a trading range over the last two weeks as the market participants are waiting for a catalyst.

EUR/USD News

GBP/USD: 3-week-old resistance-line questions 100-DMA breakout

Successful trading beyond 100-day simple moving average (DMA) fails to lend much strength to the GBP/USD pair as it struggles around 1.2520 during Friday morning. A rising trend-line since August-end, seems to challenge buyers.

GBP/USD News

USD/JPY flat in Tokyo opening hour, bears eye break below 107.45.

USD/JPY is flat in the Tokyo opening hour as we wind down into the close for the week following a data-heavy number of sessions which have left more questions unanswered and the outlook murky. 

USD/JPY News

Editors’ Picks

Euro rolling into the Asian session below the 1.1050 level

The shared currency, on the daily chart, is trading in a bear trend below the main DSMAs. The Euro has been in a trading range over the last two weeks as the market participants are waiting for a catalyst.

EUR/USD News

GBP/USD: 3-week-old resistance-line questions 100-DMA breakout

Successful trading beyond 100-day simple moving average (DMA) fails to lend much strength to the GBP/USD pair as it struggles around 1.2520 during Friday morning. A rising trend-line since August-end, seems to challenge buyers.

GBP/USD News

USD/JPY flat in Tokyo opening hour, bears eye break below 107.45.

USD/JPY is flat in the Tokyo opening hour as we wind down into the close for the week following a data-heavy number of sessions which have left more questions unanswered and the outlook murky. 

USD/JPY News

The Federal Reserve Keeps its Options Open

The Federal Reserve’s two rate cuts in as many months have satisfied market expectations for action and will give the governors time to determine if a full reduction cycle is warranted.

Read more

Gold holds on to recovery gains amid trade/political pessimism

In addition to bouncing off multi-month-old rising trend-line, Gold gains support form recently downbeat trade/political headlines while taking the bids to $1,500 during Friday’s Asian session.

Gold News

RECOMMENDED LESSONS

7 Ways to Avoid Forex Scams

The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?

What Are the 10 Fatal Mistakes Traders Make

Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

Strategy

Money Management

Psychology