When investing for a period longer than five years or more, you will certainly come across the concept of locking in returns.
It is a principle where part of investments or returns is shifted from dynamic investments to conservative ones.
We will best explain everything with a simple example. Imagine that a 30-year-old regularly buys dividend shares. He reinvests all earned income back into the purchase of additional dividend shares. After 15 years, he will change his strategy and start reinvesting only half of the dividend income, he will start postponing the other half to the term deposit. When he reaches the age of 50, he stops investing in shares and begins to build up a financial reserve by depositing money in deposit products. It will also set aside all dividends from shares on deposit products.
The main reason for locking returns is portfolio diversification according to risk. For the first few years of investing, there is no reason not to reinvest all the proceeds again in the same assets, in our case in shares. With the increasing age of the investor, it is obvious to start part of the funds somewhere where the principal will be secured. Deposits in banks, credit unions and building societies play this role in our environment. Deposits for one person within one financial institution are insured up to the equivalent of 100 thousand euros. Read also: The bank failure will not hurt so much
What can be locked?
You can lock both the return on your investment itself and the value of the investment itself. If, for example, you have one million crowns invested in dividend shares, you can transfer part of the money from this investment to a term deposit. With this transfer, you will achieve that while in the investment part the value of the principal itself may decrease at any time, this assumption is excluded on a term deposit. However, you have to accept a lower return than investments.
Part of the proceeds can also be locked. For example, one third, or part of the money to invest elsewhere or use it for some godly purpose such as an extraordinary mortgage payment, etc.
How to set revenue locking?
The strategy used to lock the proceeds must be chosen by each. You should be based mainly on what and when you need money. If a young person under the age of 40 or 45 decides to invest part of their savings in order to secure themselves in old age, they should clearly plan when to start investing part of their income in other investments. Having all the funds in shares, even when you reach retirement age, is not exactly the best idea.
Another example of revenue locking may be the rule that all revenue above five percent will be transferred to a conservative product. Part of the income is thus reinvested back into securities in the form of shares, and part, for example, into hedge funds or mortgage bonds are purchased for them.
Revenue locking can thus be divided into two groups. First of all, it is a time difference. This means that the returns from one type of investment begin to shift to another type of investment or savings after a predetermined period of time. The second group is then purely performance. Here, everything depends on how the money is valued in a given period and whether the return exceeds a predetermined level.
An alternative is the possibility of combining both of the above principles of yield locking. It is thus possible to set a rule that investment returns will be shifted every other year when a predetermined percentage appreciation is reached.
Revenue locking is not free
There are several pitfalls to locking revenue. The most significant is that by shifting part of the income, or the principal, the income will be reduced. If you receive returns each year, for example, from dividend shares of energy companies that reach an average annual appreciation of six percent, after moving part of the investment to the conservative part of your portfolio, there may be a decrease in income. While the percentage will be the same, the fixed amount you get each year from your investment will drop.
Life cycle funds or some types of life insurance mainly work with the principle of locking income. You can also lock out returns if you invest in mutual funds. Some funds, such as equity or mixed funds, are inherently directly talking about locking in returns.
However, it is not important to lock in returns after five years of investing or if you are about ten or more years old before retiring. It is also not worthwhile to lock your income when you have a very small portion of your financial assets in your investment.