Capital appreciation refers to the increase in an asset’s value. This gain is based on the increase in the market price of the asset. It primarily happens as the asset which an investor backed goes for a greater market price than the investor first paid for the asset in question. The part of the asset which is considered to be capital appreciating covers the entire market value which exceeds the cost basis, or original amount invested.
There are two principle sources of returns on investment. The largest of these is typically the capital appreciating component of the return. The other return source is from dividends or interest income. The total return of an investment results from the inclusion of both the appreciation of capital and the dividend return or interest income.
There are a wide variety of reasons why capital appreciation can occur in the first place. These differ from one asset class or market to the next, but the idea is the same. With financial assets like stocks or hard assets such as real estate, this can occur similarly.
Examples of this appreciation of capital abound. If a stock investor buys shares for $20 a piece while the stock provides a yearly dividend of $2, then the dividend yield is ten percent. A year after this, if the stock is trading at $30 and the investor obtained the $2 dividend, then the investor has enjoyed a return of $10 in capital appreciating since the stock increased from $20 to $30. The percent return of the stock price increase amounts to a capital appreciating level of 50 percent. With the $2 dividend return, the dividend yield is another ten percent. That makes the combined capital appreciation between the stock price increase and the dividend payout $12, or 60 percent. This stunning total return would please most any investor in the world.
A variety of different causes can lead to this appreciation of capital for a given asset. A generally rising trend can support the prices of the investment. These can come from such macroeconomic factors as impressive GDP growth or accommodative policies of the Federal Reserve in lowering their benchmark interest rates. It might also be something more basic having to do with the company that issued the stock itself. Stock prices could rise when the firm is outperforming the prior expectations of analysts. The real estate value of a house or other property could increase because it has good proximity to upcoming new developments like major roads, shopping centers, or good schools.
Mutual funds are another investment example which seeks out capital appreciation. The funds hunt for investments which will likely increase in value because of their undervalued but solid fundamentals or because they have earnings which outperform analysts’ expectations. It is true that such investments often entail larger risks than those alternatives picked for income generation or preservation of capital, as with municipal bonds, government bonds, or high dividend paying stocks.
This is why those funds which focus on capital appreciation are deemed to be more appropriate for those investors who have a higher tolerance for risk. Growth funds are usually called capital appreciation investments since they pour their funds into company stocks which are rapidly expanding and boosting their shareholder values at the same time. They do employ capital appreciation as their primary investment strategy to meet the expectations of lifestyle and retirement investors.