As the equity investment market in Canada is in strong decline as of late I am doing a few posts on investing concepts. I strongly recommend you follow the series in sequence. I started Sunday with some high level concepts and focused yesterday on equity investing.
Don’t need the capital, hold!
The object of investing is to provide fuel for the economy while making some money for yourself. Invested funds are used to produce products or services which are paid for with money which is used by the producer to pay wages, produce more product and services, return money to investors and buy other stuff. This in turn puts more money in the economy and everything spirals up.
When you provide capital to fuel the economy, as noted yesterday, even if the investment drops in value (unrealized loss) as long as you don’t need the capital back you can hang on until you have an unrealized gain. You could then sell and realize the gain or not and just continue to hold the investment.
Why would you do this?
The intent of investing is to make money. This can be from dividend/interest payments or capital gains. The goal is to have optimal returns and if you can grow your funds through all all three ways (dividend, interest, capital gains) of course this is a good idea.
That being said, if you buy the investment and get a solid steady continuous return with little risk without fooling around with the capital by just gathering income, than why not.
And the Point
These days of doom and gloom, the media is screaming about the economic downturn and capital losses in the equity markets (among other bad things). The reality is, if you don’t sell your capital investment you don’t lose anything.
In fact, a possible but exaggerated example might be the case where you invested $1 million in a bunch of blue chip stocks with dividends of 10% or $100,000 a year. From today, the capital value of the stocks might drop to $500,000 (don’t sell yet so not actual loss) and five years from now it might be $2 million. If you hold the investment for 5 years you will earn $500,000 in dividends and then $1 million in capital gains (if you sell at that point, I would probably still hold).
All just because you held on.
The Caveats
Of course if the company stops paying a dividend or goes bankrupt you will ultimately lose. The thing to consider though, is how likely is this for blue chip stocks (it does happen but not often) and if it does there are probably more problems – big companies collapsing can’t be good all around.
And the final word is, obviously if you are leveraged (owe money) or have an unexpected need for the capital then this approach does not work.
If you can follow the buy and hold approach, though it is not guaranteed the likelihood of a reasonable reward is a decent possibility.