Capital is the terms splashed across marketing materials for investment firms, but what does it mean, and how does it relate to your money?
By definition capital refers to wealth in the form of money or other assets that are available for a form investment. In economics, capital is a factor of production and it can be used to generate something else.
Capital is not your income, or the amount you have available to spend, it is a measure of your overall wealth. It includes your pension, any property you might own, as well as your savings and investments.
The difference between cash and capital
Whilst capital is a way of referring to money, there is a difference between capital and cash. Cash is the money you have available at a moment’s notice; it is what you use to buy coffee or the morning newspaper. This spending money is not something that will help you in the long-term, it caters for your day-to-day needs but is unlikely to appreciate in the future.
One way of looking at the difference between capital and cash is that cash is something you don’t invest, it’s something you don’t need. You can use any excess cash to invest, but when you do, you don’t have cash anymore, you have capital. If you needed to spend that capital, you would need to convert it back into cash.
For example, if you own a home, you don’t view that as cash, or even money, but it is part of your overall wealth. It is an asset in the same way as an investment is, you would need to sell it in order to be able to spend the value. And like an investment, you hope that the property will gain in value over time, but you buy it knowing that markets may not work in your favour.
Why could capital be at risk?
Cash is a constant, a pound coin is always a pound coin, but the amount you can buy with that pound can change over time. Capital can suffer from fluctuations; the housing market can crash, and share prices can drop. Sometimes these drops can be to the extent that you lose the majority of your wealth. This is why we advocate diversification at Moneyfarm, by investing in a range of assets you reduce your exposure to the volatility of any one capital investment. Thereby reducing the extent to which your capital is at risk.