Posted on November 24, 2009 - by musicwhiz

Recycling and Reallocating Capital

Photo by e-magic

As investors, it is important to regularly review our shareholdings and to ensure our money is being put to productive use. This is because the enemy of inflation is always out there and will constantly and consistently erode the value of your cash holdings, making them worth about 3-5% less than the previous year. The insidious effects of inflation have been discussed in many economic textbooks and therefore one cannot afford to leave their money idle in bank accounts earning a very miserable and paltry 0.5% per annum. This brings me to the topic of recycling and reallocating capital, and I shall touch on each in the following paragraphs.

Recycling capital is one method whereby one can ensure one’s capital is always growing and put to productive use. This method involves selling shares which one feels has not much further potential for capital gains, and moving the capital to an undervalued investment with more potential for capital gains in future. Of course, this is predicated on the fact that one will be able and willing to look for undervalued gems to park his money in, and to adopt a patient attitude to be able to recycle his capital. One also has to be able to determine (according to his own personal prescribed philosophy), what is meant by “over-valued” and “under-valued”. Thus, this method of recycling capital may sound easy but is in fact fraught with considerable risk.

Take for example an investor who invests $1,000 in Company A. Company A grows over the years and his investment becomes $2,000 over 4 years. The investor then recycles the new capital of $2,000 into Company B which he feels has a growth rate of 20%, compared to say 10% for Company A as its period of rapid growth is over. Thus, the investor wishes to grow his capital by 20% to $2,400 instead of being content with $2,200. Read more…

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