Capital vs Investment: Definition, Examples & More
For individuals just starting to explore the money markets, understanding the difference between capital and investment, profit and interest, mutual fund, and SIP can be challenging.
In this article, we will help you understand the difference between capital vs investment.
Capital = Productivity
While there are several definitions of this, one that makes the concept easy to understand is: Capital is anything tangible or intangible that increases productivity.
Tangible capital comprises computers, manufacturing machines, factory space, etc. Intangible capital comprises elements like human resources, training, knowledge, etc.
Investment = Higher Returns
On the other hand, investment is when money is put into any instrument with the objective of getting higher returns. So you invest in stocks and equities to get better returns than just keeping your funds in the savings account.
There are different views of what accounts for capital. Some experts say loans can also be considered capital as they can be used to purchase a TV from which people can learn skills and make themselves more productive, but that is stretching the analogy too far.
What are you expecting your money to do?
From the perspective where you have funds and you wish to put them to good use, you need to first and foremost define what you wish to achieve in the long term.
Are you a salaried person earning a salary and looking to get good returns on your savings? Then you should be making investments in various financial instruments such as equities and mutual funds.
On the other hand, if you are an entrepreneur or would like to be one, you may be keener on purchasing goods/items that will help you further your business.
It is important to understand that when you purchase capital goods, they depreciate over time, that is their value goes down in the market over time, and you have to put further money into the purchase to maintain it and keep it running at optimum capacity and get the best levels of productivity from it.
1. Returns on capital
Your capital can bring you direct financial gains only when you sell it. Hence there is a concept of capital gains tax: short term and long term.
When you purchase an asset like residential property and sell it in less than a year, you will have to pay short-term capital gains tax on it equivalent to your existing income tax slab.
If you sell the asset after one year of purchase, you have to pay a long-term capital gains tax of 15% on the asset’s appreciation since purchase.
2. Returns on investment
Investments in the markets are done with the exclusive purpose of obtaining higher returns. Accordingly, you can get returns on investment in the form of interest, dividends, stock options or bonus shares, etc.
These are usually declared annually, and you do not need to sell your investment to claim your benefits.
Further, purchasing capital assets usually requires large monies, whereas investments can be done in small sums via SIPs and other regular investment methods. Of course, you can make a capital asset purchase with a loan and EMI as well.
3. Money for the future
Now if you are looking to save money and build a corpus for your future, say for your child’s education overseas; you may be wondering what to do: build capital or make investments.
You must seriously consider how many years you will need the funds. If you are looking at long-term returns, building a capital asset and then selling it when the value appreciates adequately is a good idea.
But if your horizon is a short one, you are better off with investments in financial instruments.
How you will be able to redeem it?
Capital assets are usually difficult to liquidate but can work as collateral if you want to take a loan. Alternatively, when you make investments, these are more liquid in nature.
You can disinvest in parts and the process is as easy as getting money out of your FDs.
So when you are planning to build your corpus, keep all of these points in mind.
Consult an expert advisor to get the right plan