Weekly Thoughts 28 March 2014

A bit long and technical this week. Apologies for that. But something I need to get off my chest again!

In my last weekly thoughts I wrote about how, once purchased, the capital value of a rental property no longer had an effect upon the rental income being paid. Once an investor has bought into appropriate assets that can pay an income, the capital value of such assets has no bearing on the income, nor on the income’s reliability or its growth. The underlying assets held do that through how they are managed, what they’re made up of and what form of income is derived from them.

Someone asked me earlier this week what return I would be able to give a retired person with 2 million Rand over one year. I know what he’s working out: if he can do better with their money in his business or not. I said to him that I cannot tell him what capital growth return I can give him, because no one can. That I work on income yields for such a person and not capital growth and that if I gave him an ideal percentage yield he will think, “that’s easy for me to beat”. I said that I could not answer him, that it was too complex.

I read in a recent financial piece about how first world (offshore) markets are offering good value and that it is currently possible to invest in some great companies on a dividend yield of a healthy three to four percent. They are correct. Even more than 4% is currently possible. A yield of 4% would mean that an investment of one million dollars into the shares of such a company would produce an income over a year of 40 000 dollars. However, once purchased, the value of the share of this company would no longer have an effect upon the dividend income being paid. The dividend received is an amount of money paid per share owned, hence it would be the number of shares being held and not the value of the shares held that now determine the income. If the company makes good profits then it might pay more money next time, even if its share price has dropped by 8%, for example. Now if I’d told the chap who asked me the question above that I’d give 4% he’d think, “why so low, the markets have done far more than that?” Because he is thinking of capital growth providing income, which has no certainty.

So if you are an income dependent investor and we’ve invested your wealth through purchasing assets capable of paying an income (Marriott funds for example) and you are able to live off the yields provided by that mix of funds, then the value of your capital going forward is largely irrelevant and not something that you need to worry about too much! If however, someone has invested their wealth for income through a system whereby the funds are held on a speculative growth basis and a few units/shares need to be sold off monthly in order to put cash in their bank account, then capital growth or loss each month becomes what makes them worry at night. And no one can do much about capital growth of any asset, it’s a market & emotive driven event.

This is a difficult issue to grasp, so don’t worry if you’re not following me all the way yet. Most people don’t understand this issue, including most financial advisors.