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Decoding Your Investment Performance

Portfolio Rebalancing
When was the last time you checked the balance of your investment portfolio?

As part of our commitment at Ranch Capital Advisors, we ensure regular communication through client review meetings. These sessions are not just routine checks; they are our way to stay connected with you, understand your life changes, address your financial inquiries, and review your investment performance. Our goal is for you to have a clear understanding of your investments, and I have found that a common area of confusion tends to be distinguishing between income and capital gains (or losses) as it pertains to total returns and investment performance. I hope to clarify these concepts, so you might want to bookmark it for future reference.

Total Gains and Losses Explained

When reviewing your monthly statements, investment performance can be thought of in two categories:

  • Capital gains and losses from the price movement of your holdings for the given month.

  • Income generated from interest and dividends for the given month.

Understanding these categories is crucial for interpreting changes in your portfolio.

Realized vs. Unrealized Gains and Losses

Realized Gains and Losses: These occur when you sell an investment for more or less than its purchase price. For instance, buying a stock at $100 and selling it at $120 results in a realized gain of $20. Importantly, you only 'realize' these gains or losses upon selling. It's akin to your home's value fluctuating; it’s worth changes on paper, but the actual gain or loss is only realized if you decide to sell. Nothing is gained or lost until the sale is finalized.

Unrealized Gains and Losses: This represents the increase or decrease in the share price of your investments that you hold for a given period or since inception. For example, if your portfolio grew impressively in 2023 and you did not sell any holdings, those are unrealized gains—valuable on paper and impactful for portfolio growth, yet not subject to taxes until realized.

Understanding Income from Investments

Your investment income can come in two forms: dividends and interest. Investment income is the cash that is being generated from your portfolio regardless of any short-term price movement of your holdings. Investment income can be distributed to you in order to supplement your income, it can be held in your account in the form of cash, or it can be reinvested to purchase additional securities.

Dividends: Paid from a company's profits to shareholders of stocks, dividends are a regular income source typically paid out quarterly in the form of cash. You may have heard us compare dividend income to rental income. For example, if you own a rental property, and receive regular rent payments from your tenants, even if the underlying value of the property fluctuates, you still receive that same rental income. Both rent checks and dividend checks have proven to be a very reliable source of income, regardless of market fluctuations.

Interest: Earned from lending money (through vehicles like bonds, CD’s, or savings accounts), interest payments are fairly straightforward and secure. For example, an average interest income of 5% from a money market account adds a predictable income flow to your investments without enduring market risk or price fluctuations.

The Power of Reinvesting

Choosing to reinvest your dividends and interest can significantly contribute to your portfolio's long-term growth. Reinvesting means using the income earned to purchase more shares or bonds, compounding your investments over time. Though taxes are due on reinvested earnings, this strategy can accelerate portfolio growth, enhancing your financial wealth in the long run. Of course, some investors choose to take their dividend and interest income as cash and not reinvest it. This allows an investor to enjoy the income from their portfolio and use it to supplement or enhance their lifestyle. Many of our retired clients live off the investment income generated from their holdings.

Capital Gain Distributions

Particularly with mutual funds, capital gains can be distributed to shareholders even if you did not sell any of your mutual fund shares. This distribution from the fund company typically arrives late in the year and is the result of any realized gains that the portfolio manager caused through trading. Whether you take the capital gain distribution in cash or reinvest the distribution back into your fund, tax obligations still apply. Being proactive about understanding these gains and their tax implications can help avoid surprises during tax time.

Final Thoughts

I hope this article helped to demystify the core aspects of investment performance—capital gains and income. By grasping these concepts, you're better prepared for discussions in our review meetings and equipped to make informed investment decisions confidently. Our next newsletter will delve into the tax implications of your investment gains, losses, and income, furthering your understanding and confidence as an investor.

Always remember that investing is a journey that requires a clear understanding of the terrain. Capital gains, whether realized or unrealized, and investment income through dividends and interest, are fundamental concepts that shape this landscape. By familiarizing yourself with these terms and leveraging strategies like reinvestment, you're not just passively waiting for returns—you're actively engaging in the growth of your financial future. At Ranch Capital Advisors, we're here to guide you through this journey.


Abigail Skipper


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