At Pearler, we’re all about equipping you with the knowledge you need to invest with confidence. This means giving you insight into different investing terms, even if they’re not always relevant to your own investing journey. In this explainer, we’re delving into the concept of capital growth.

What is capital growth?

Capital growth is all about watching your investments grow in value over time.

Imagine you buy a property or some shares in a company. If, after a few years, that property or those shares are worth more than what you paid, you've experienced capital growth. It's like seeing a seed you buried sprout into a flourishing plant. Investors love this because it means their initial choice to invest is paying off – literally.

This growth is a key target when you’re putting your money into things like shares, ETFs , or real estate , aiming to sell them later at a higher price. It’s different from earning dividends or interest, which are like the little bonuses you get along the way.

What does capital growth look like...

...for shares?

Capital growth for shares occurs when the share price of a company increases over the time you hold it. For instance, if you buy shares with a purchase price of $10 each, and they rise to $15, that $5 increase per share represents your capital growth.

It's a reflection of the company's improved performance or market confidence, making your investment more valuable. This growth is the ultimate goal for some investors, who aim to sell their shares at this higher price for a profit. (On the other hand, some investors prefer to go for dividend-paying stocks .)

...for ETFs?

Capital growth in ETFs happens when the market value of the ETF's portfolio increases, leading to a rise in the ETF’s share price.

Growth can result from the collective performance of the assets held within the ETF, such as shares, bonds , or commodities, reflecting overall market gains or strategic asset management.

...for property?

In property , capital growth is seen when the market value of real estate appreciates over time.

Price increases can be influenced by factors like improvements to the property, developments in the area, or general market trends.

For many, this appreciation in property value is a significant aspect of their investment strategy. This is particularly the case for investors who hope to sell at a higher price for a substantial profit.

...for commodities?

As far as commodities are concerned, capital growth occurs when the market prices of goods like oil, gold, or agricultural products increase over time.

This growth often reflects changes in supply and demand, economic factors, or geopolitical events.

Commodities can be volatile investments, but successful timing and market conditions may lead to significant appreciation in value.

...for crypto?

Capital growth for cryptocurrencies manifests as an increase in the market value of a digital currency.

Growth is driven by factors like investor sentiment, technological advancements, regulatory changes, and broader market adoption.

Cryptocurrencies are particularly volatile, making them historically high-risk assets. (Although, to be fair, all investments carry risk.)

Capital growth for long-term investors

Capital growth typically requires a long-term investment horizon, but over that time, if your investments perform well, it could really boost the value of your assets. This type of growth is especially crucial if you're focusing on big goals like saving for a house deposit, funding your kids’ education, or preparing for (early) retirement.

When it performs well, capital growth can make your investments work harder for you through the power of compound interest . This means your gains start to generate more gains because the increased value of your investment becomes the new base for future growth. Let's say you have a diversified portfolio of shares or real estate that appreciates every year. The growth isn't just on your original amount, but also on the gains from previous years.

Plus, capital growth can potentially be your ally against inflation . As prices rise over the years, the rising cost of living can eat away at your money's value. But if your investments are growing in value, they could help counteract this, maintaining or possibly even boosting your real wealth.

Just remember that capital growth isn’t a given – more on this a little further down!

Tax implications of capital growth

For investors, capital growth is often a key goal. It signifies not just the recovery of their initial outlay, but also the achievement of real, tangible profits.

However, when these profits – known as capital gains – are realised, meaning the assets are sold for a higher price than they were bought, they become subject to capital gains tax (CGT) . CGT is a tax levied on the profit made from selling certain types of assets.

The rate of CGT depends on factors like the duration for which the asset was held, the investor's tax bracket, and specific exemptions or deductions they might qualify for. For example, if you hold an asset for longer than 12 months, you’re entitled to a CGT discount.

Remember, this information is general in nature and shouldn’t be treated as tax advice. Reach out to a qualified tax accountant for CGT advice tailored to your situation.

Capital growth – a case study

Meet Alex, a savvy investor who decides to invest in (the purely fictional) "FutureTech Growth ETF," which focuses on emerging tech companies.

Over 10 years, the ETF performs exceptionally well, with Alex's initial investment of $20,000 growing to $40,000. Thrilled with the growth, Alex decides to sell his shares to fund a major home renovation.

However, with the sale comes the obligation to pay CGT on the $20,000 profit. Since this was a long-term investment, Alex benefited from a lower tax rate on long-term capital gains.

After paying the tax, Alex still has a substantial net gain, reaffirming his investment decision.

Should you always aim for capital growth?

While there are obvious benefits to aiming for capital growth, only doing so could pose a few risks.

• Volatility: Investments aimed at capital growth, like high-growth shares or cryptocurrencies, can be highly volatile. Their prices might fluctuate widely in short periods, which can lead to significant losses if the timing of selling isn’t optimal
• Risk: Higher potential returns are often accompanied by higher risk. This means that while there's a chance for substantial gains, there's also a possibility of losing a significant portion, or even all, of your invested capital
• Market timing: Successfully investing for capital growth often involves market timing – knowing when to buy and sell . This can be challenging, even for experienced investors, and getting it wrong can impact returns
• Tax implications: When assets are sold for a profit, CGT must be considered. The tax impact can reduce the net gains from the investment, especially if the assets are held for less than a year, attracting higher short-term capital gains taxes

Assess your risk tolerance , investing timeline, and financial goals thoroughly before committing to strategies focused primarily on capital growth. After all, there are other factors to consider before choosing an investment – like its passive income potential, for instance.

Stay informed, make strategic choices and keep a close eye on your investments – and never hesitate to reach out to an expert if you need professional guidance.

Happy investing!