With the footie season well underway, I know my wife finds it quite comical listening to the rhetoric and pre-match talk that commentators make about upcoming games.
It’s kind of a deja vu experience, isn’t it? Same talk, different season. Like football word bingo.
Not a lot seems to change from year to year, but football fans everywhere take it oh so seriously. Yes, the players and coaches come and go, but the questions about who will win are perennial.
And it drives my wife nuts!!! Every second word is outstanding and full of repetition.
In our devotion to the cause, we hinge our happiness on the outcomes of big deciders, as though our very lives depended on it.
I’ve often wished people would apply the same fervent enthusiasm to the big financial questions in their lives because believe it or not, there are analogies between football and financial services.
A stretch you say. Just stay with me.
Every year I field the same kinds of questions from clients. Obviously not around football (although our conversations can digress at time), but rather as they relate to different each individual’s or couple’s unique set of circumstances.
What’s the most tax effective way for me to structure financially for retirement?
How do I capitalise on changes to superannuation laws?
What do I do with a financial windfall like an inheritance?
What would be best for me to focus on: growth versus yield?
It’s this last question which came up in a discussion with a client last week and which I feel warrants more airplay here in the blog.
In every way, the question of growth v. yield question is a personal one and it’s a big decider irrespective of where you are in life.
In the case of the client who asked me last week, this question related to what to do with the some extra cash she had on hand. She specifically asked, would it be best for her to put that excess into her home loan.
I don’t think the growth v. yield question can be answered properly unless we clearly define what each is and fully appreciate they are different things.
Growth of any investment relates to the increase in its value. For example, you might purchase a property for $500k and in twelve months the value of the land goes up by 10 percent, at which time it’s worth $550k. That’s what I refer to as the growth return.
Yield relates to the income derived from an investment. Take that same property, which is an investment and the yield is the rental income generated from the property.
This principle applies to shares as well. If the share price goes up or down, that affects the share’s value. Dividends derived from the share represent the income yield from that investment.
So what’s the point?
What I have noticed is that people have a tendency to consider properties in terms of yield (rental returns) and shares in terms of growth (whether the share is going up or down).
They don’t consider the yield and growth aspects of each investment type.
If my client places her spare $10k into the home loan of her principal place of residence, she doesn’t earn an income (or yield) from that investment per se, however she will enjoy the benefit of saving interest expense. You could say that the yield on that money, is the saving of interest.
If all goes well, this might even correspond with growth in the property’s value.
If she places the $10k into an investment property, even if the property’s value has increased, she may have a negative return (yield) because the expense of maintaining it has outweighed the return – or the value of the income derived from rent, is outpaced by interest and costs.
If she took that same $10k and invested it in shares, and the shares’ value dropped, she may still derive a yield from her shares, but the overall value of this investment has decreased.
This is just one example, but the point is decisions about growth v. yield in respect of investments should not be made in isolation.
Without taking into account all the information from a spherical perspective, rather than a perspective that is one dimensional, we run the risk of making a judgement call based on the first set of numbers that come across our table.
The upshot is, you could be missing pivotal elements that could impact your ‘big decider’ financial decisions.
Long term, this approach can result in us falling well short of our financial goals as sometimes people get so focussed on short term returns, and forget their long term goals.
When it comes to the big decisions, it makes sense to get seek informed and timely counsel, which makes your financial planner and accountant a good place to start.
I think it’s also helpful to remember that just like the football commentators and their annual spruiking about winners and losers, it is necessary to regularly the review growth v. yield question as it relates to your investments.
Understanding that it’s not a one-off question to be answered and not revisited will help keep you on track with your with your financial management goals.
It also sets you up to enjoy the benefits of any decision you make.
Are you facing a big financial question? Or have you recently reviewed the growth v. yield strategy on an investment? How did it go? What did you learn?
Share your experiences here in the comments section.
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