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If you don’t know the difference between these two, there is a chance that you pick the wrong security product
Different financial securities serve different investment objectives. A popular objective is regular income. This contrasts with financial securities products which are structured for wealth creation. You need to know whether it is regular income or wealth creation which you seek.
If you don’t know the difference, there is a chance you pick the wrong security product. The three things to look for when deciding whether your investment goal is income or wealth are—defined return, period of investment and change in capital value.
Wealth creation
Wealth refers to your basket of assets; cash, land, property, gold, shares, bonds all added together. For investors, wealth is created by buying or investing in these assets with an expectation that the price will move higher. This rise in price over a period of time is what will lead to growth in wealth.
Buying physical assets like land and built up property gives you income if you utilise the asset to create something which you can then sell for income. Hence, financial and physical assets can give you both income and wealth. In property for example, income comes from rent and wealth comes from an appreciation in value of the property. Similarly, in shares, income comes from dividends and wealth comes from change in price.
Gold is an asset where there is no potential for income and any value is earned only with price change. To create wealth from assets, attention should be paid to the quality of the asset. A good quality asset has a higher potential of its price increasing in future. You can face a fall in price or wealth depletion if you are holding on to a poor-quality asset. Property values and share prices can also fall with time.
In case of shares, prices can decline due to external factors. However, a good quality share is likely to recover over a period of time as the income generated by the underlying company increases. Property values too suffer interim fall; this is less visible on a daily basis and is realised only when a transaction happens.
The risk is that wealth creation is not a definite phenomenon. Investors should ideally hold good quality assets for relatively long periods of time to benefit from potential increase in value.
Regular income is defined
As opposed to wealth creation, earning regular income is a more defined process. Bank and corporate fixed deposits, debentures and savings schemes are financial securities geared towards generating regular income. For example, a 3-year fixed deposit of 8% per annum, will earn you Rs8,000 per Rs1 lakh of investment each year. The pay-out period may be defined as per quarter, semi-annual, annual or you can even receive all the collected interest at the end of a long period. Regular income hence, is not a growth in wealth or value of assets.
When you buy an asset for wealth creation, the holding period and the potential return is not defined at the start. Unlike this, for investments made for regular income, the period and return are defined. In case of the latter, there is no change in your original investment or scope of capital growth, which you will get back at the end of the predetermined tenure.
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