What is ‘Capital Appreciation’
Capital appreciation is a rise in the value of an asset based on a rise in market price. It occurs when the asset invested commands a higher price in the market than an investor originally paid for the asset. The capital appreciation portion of the investment includes all of the market value exceeding the original investment or cost basis.
BREAKING DOWN ‘Capital Appreciation’
Capital appreciation is one of the two main sources of investment returns, with the others being dividend or interest income. The combination of capital appreciation with dividend or interest returns is referred to as total return. Capital appreciation can occur for many different reasons in different markets and asset classes. It can also occur with financial assets such as stocks or with real assets such as real estate.
Example of Capital Appreciation
An investor purchases a stock for $10 and the stock pays an annual dividend of $1, equating to a dividend yield of 10%. A year later, the stock is trading at $15 per share and the investor has received the dividend of $1. The investor has a return of $5 from capital appreciation as the price of the stock went from the purchase price or cost basis of $10 to a current market value of $15; in percentage terms, the stock price increase led to a return from capital appreciation of 50%. The dividend income return is $1, equating to a return of 10% in line with the original dividend yield. The return from capital appreciation combined with the return from the dividend leads to a total return on the stock of $6 or 60%.
Causes of Capital Appreciation
The value of assets can increase for several reasons. There can be a general trend for asset values to increase including macroeconomics factors such as strong GDP growth or Federal Reserve policy such as lowering interest rates. On a more granular level, a stock price can increase because the underlying company is growing faster than analysts expect, or the value of a house can increase because of proximity to new developments such as schools or shopping centers.
Investing for Capital Appreciation
Capital appreciation is often a stated investment goal of many mutual funds. These funds look for investments that will rise in value based on increased earnings or other fundamental metrics. Investments targeted for capital appreciation tend to have more risk than assets chosen for capital preservation or income generation, such as government bonds, municipal bonds or dividend-paying stocks. Because of this, capital appreciation funds are considered most appropriate for risk-tolerant investors. Growth funds are customarily characterized as capital appreciation funds as they invest in the stocks of companies that are growing quickly and increasing their value. Capital appreciation is employed as an investment strategy to satisfy the retirement and lifestyle goals of investors.
Capital Appreciation Bond
Capital appreciation bonds are backed by local government agencies and are therefore known as municipal securities. They work by compounding interest until maturity, when an investor receives a lump sum that includes the value of the bond and the total accrued interest. This differs from regular bonds, which typically pay interest payments each year. These types of investments are often used to fund municipal projects such as parks and roads.