Back in September, I did a post on purchasing power risk in certificates of deposit. I asked readers to differentiate between savings and investment. Savers tend to focus on protecting principal at all costs, often to see the purchasing power of their savings erode over time from inflation.
Investors should expect a positive real rate of return on their investments. A real return is a return that exceeds the inflation rate, so purchasing power and wealth increases over time. The problem is that market and investment prices don't always go up.
"No tree grows to the sun" is one of my favorite investment adages, although Netflix is giving it a go, up $54.99 per share to $388.72 per share the day after the release of its quarterly earnings -- on a day when the stock market, as measured by the Dow Jones Industrial Average, was down 176 points.
Total return looks at capital gains and losses along with and cash the investment throws off -- either by paying a cash dividend or interest payments. If IBM is paying a 2 percent dividend yield and you expect to earn 7 percent on an investment in the company's shares, the other 5 percent has to come from price appreciation.
Whether it's the "bird-in-hand" theory or the caution to "never touch principal," income-oriented investors can be blind to how capital losses reduce their total return. The total return of the S&P 500 in 2013 was 32.39 percent, with 1.91 percent of the yield attributable to dividends. It was a good year for domestic equities, but the new year is getting off to a rockier start.
My point is that falling stock prices, or bond prices for that matter, can wipe out the income yields in short order. Investors shouldn't just focus on income. They need to look at the big picture when it comes to investment returns and consider capital gains and losses, too.
How about it? Are you an income-oriented investor?
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