Making Money From Stocks

Investment returns from stocks are generally derived from two main sources: capital appreciation and dividends. The combined investment gains from both capital appreciation and dividends are often referred to as total returns.

iFAST Research Team
iFAST Research Team06 Dec 2016 0 Views
Making Money From Stocks

Investment returns from stocks are generally derived from two main sources: capital appreciation and dividends. Investors make money through capital appreciation when they buy a stock and hold on to it long enough, before selling it off to other investors at a higher price. Dividends, which represent a portion of a company's profits that is paid out to shareholders, are also a major source of investment returns from stocks. The combined investment gains from both capital appreciation and dividends are often referred to as total returns.

Capital Appreciation

Capital appreciation (also known as capital gains) occurs when the market price of a stock increases above the price that an investor originally paid for the stock. In other words, investors make money when the price of a stock that they own rises above the price that they initially paid for it. If investors continue to hold on to the stock after the increase in stock price, the investment gains are considered unrealised (also known as paper gains) as the profitable stock has not been sold in return for cash. In the case of a paper loss, investors may decide not to realise it in hopes that the stock price will eventually recover. Investment gains and losses are realised only when the stock is sold, and because stock prices can be volatile depending on market conditions, investors will only know how much gains they have made from capital appreciation when they sell the stock.

Dividends

When companies generate profits from their businesses, they distribute a portion of their earnings to shareholders as dividends, either as cash payments or stock dividends. Dividends are a way to ensure that shareholders are rewarded for their investment when companies do well. Dividends are an important contributor to portfolio returns overtime. Unlike capital gains, which are not realised until investors sell off their investment holdings, dividends provide investors with a steady stream of realised income that can be reinvested to harness the power of compounding in growing their investment portfolios. Another advantage of dividends is that investors get paid even when stock prices are falling, helping to cushion some of their losses. However, there is no guarantee that dividends will be paid out every year, although most companies have in place a dividend policy that provides the management with guidance on the proportion of earnings to pay out to shareholders as dividends. Companies that are still growing rapidly usually do not pay any dividends, as they prefer to reinvest their profits back into the business in hopes of increasing earnings even more.

What Are Your Potential Returns?

Among the various asset classes, stocks have historically offered the greatest potential for investment returns, although with high levels of volatility along the way. While global bonds delivered an annualised return of 6.07% from 1987 – 2015, the US stock market (represented by the S&P 500 Index) managed a comparatively higher annualised return of 7.83% (returns in USD terms including dividends), with the exponential rise in the stock market highlighting the power of compounding investment returns over the long term. While historical performance is not representative of future performance, an investment in stocks during this period would have significantly outperformed a bond investment.

Chart 1: Performance Comparison Of Stocks And Bonds


 

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