5 types of investor capital

Posted on

Speaking of investor capital, two things are most often meant: a long-term passive portfolio of funds or stocks, or a trader’s account for active trading. This simplistic view allows investors to pass by a number of effective strategies and tools. Meanwhile, the main task of the investor is to achieve the set financial goals, and this requires not only an investment portfolio, but also other parts of the capital that perform special tasks and are formed according to special rules. There are five of these parts.

Consumption capital

Investing is a long-term process. The key to success in it is financial discipline and the implementation of repetitive sequential actions, and the biggest difficulty is maintaining the proper level of motivation. Investments require a change in financial habits, which will lead to positive results only years later. Therefore, in parallel with savings, it is necessary to raise your level of spending. Only in this way can you feel that you are really getting richer, a simple increase in the numbers on your accounts does not give such a psychological effect. It is only necessary to ensure that the increase in expenses does not exceed the increase in income.

Consumption capital is the money an investor spends on current needs. There is usually time between earning income and spending, and you can and should use it to your advantage. Money must work, this thesis is undeniable, even when it comes to terms of several days. The best tool for consumption capital is bank debit cards. Interest is accrued on the balance of funds in the account, and when making a purchase, part of the money spent is returned in the form of cashback. Using special offers from banks, you can get up to 7-10% of the amount of annual income. Novice investors often complain about the lack of funds for investment, but at the same time stubbornly ignore the opportunities for generating income from the money that goes to current consumption.

Close work with consumption capital is relevant for novice investors. With the growth of wealth, this part of the capital plays a smaller and smaller role.

financial protection

If the investor is not yet a dollar multimillionaire and does not live on interest from the capital, then his expenses and investments are financed from active income. Often this is the only source of funds. His loss changes the entire financial situation for the worse: plans are not fulfilled, goals are not realized. You can partially protect yourself from force majeure with the help of financial protection.

You need to protect yourself from two troubles: loss of income and large unexpected expenses. Financial reserves are needed: the so-called airbag and insurance. By airbag we mean the amount of money that, in case of unforeseen circumstances, is used to compensate for current expenses. The optimal size of this reserve ranges from 3 to 6 monthly incomes, and the larger it is, the better the protection. To create an airbag, reliable and liquid financial instruments are required, they practically do not give profitability, so too much stock is also bad. For the reserve fund, bank deposits or bank cards are suitable. At the same time, it is better to use a separate bank card to store this money.

Insurance is the transfer of risks. You periodically pay premiums, but in case of force majeure, the costs are covered from the insurer’s funds. You can insure an apartment, cottage, car and other property; and you can own life and health. In case of trouble, this will help offset unforeseen costs.

What exactly to insure and for what amounts everyone decides for himself, but an investor without financial protection runs the risk of one day being left with nothing.

Financial Independence Capital

Every investor will someday face the fact that they will no longer be able to receive active income: they will either retire or become a rentier and live on interest from capital. Obtaining a permanent passive income requires serious investments, and the sooner you start building the capital of financial independence, the better.

Investments in financial independence are usually long-term, so you can use risky instruments with the potential for high returns. The main thing is to invest regularly and not withdraw money from the portfolio for a long time. If you are not confident in your financial discipline, you can build a portfolio using programs that do not allow early termination of the contract and missed monthly payments. Otherwise, a regular investment portfolio in a brokerage account will do.

Investment portfolio

The main difference between an investment portfolio and financial independence capital is periodic withdrawals of money. All objectives of the investor are financed from this part of the capital. Major purchases, travel, family events – the list can be very long. And you don’t have to wait for financial independence to realize these goals. Remember, you need to become richer already in the process of capital accumulation, and not after you start living on interest.

Periodic withdrawals of money require liquidity from the instruments in the portfolio. It is a shame to postpone the realization of a financial goal just because the contract cannot be terminated before the end of its term. Endowment life insurance, structural products and all instruments without the possibility of early withdrawal of funds are better not to be used in an investment portfolio. A balanced combination of conservative and risky instruments on a regular brokerage account will do.

Financial independence capital and investment portfolio are best separated physically.

Investor’s reserve capital

When an investor accumulates funds for a long-term financial goal, he only welcomes crises and the fall in the value of instruments. Such situations allow him to buy assets at reduced prices, which will necessarily affect the final long-term results.

But any long-term period ends sooner or later. If 10 years before the goal is reached, a market drop of 70% is a rare opportunity, then 1 year before the goal is a disaster. Therefore, as the goal is approached, it is necessary to reduce investment risks by shifting funds to more conservative instruments. It is better to start doing this in advance (at least 5 years before reaching the goal) so that a year before the goal, the entire amount necessary for its implementation is in conservative instruments, such as bonds or bank deposits.

It is desirable that the capital of investors consists of these five parts. Their proportions differ depending on the goals, financial capabilities and the amount of capital. The main thing is to clearly understand what this or that instrument serves, and, based on this, determine the amount that will be invested in it.

 

One thought on “5 types of investor capital

Leave a Reply

Your email address will not be published.