The income-only outlookThe total return on an investment portfolio generally comes from two sources: income and changes in price. The income return is paid out in the form of dividends or interest, and the capital return reflects price increases or decreases.
Many pre-retirees and retirees follow an income-focused approach, maintaining a portfolio with a yield that they anticipate will meet their spending goals. But even the best-laid plans can fall short. For example, with interest rates near historical lows for the last several years, investors relying on income from bond portfolios have been pinched.
What happens when an investor needs—or wants—to spend more than the portfolio is generating? Michael DiJoseph, an investment analyst in Vanguard’s Investment Strategy Group, said, “Many investors tend to tilt their portfolio’s asset allocation even further toward income-producing assets, perhaps not realizing that this can be self-defeating.”
Focusing strictly on income—for instance, overweighting higher-yielding bonds (such as corporate or longer-dated bonds) and dividend-paying stocks—can distort a portfolio’s asset allocation to the point that it no longer aligns with the investor’s time horizon, risk tolerance, and long-term goals.
The income + capital appreciation approachTaking a holistic approach to investing by focusing on a portfolio’s total return—both income and capital appreciation—can help investors choose a diversified asset allocation that balances their tolerance for risk with their desire for return.
A total-return approach allows retirees to have more control over the size and timing of portfolio withdrawals. Because an investor can draw from capital appreciation rather than just income, the amount they can withdraw isn’t determined by the amount of their last fund distribution. Additionally, they can make adjustments in response to changes in the market value of the total portfolio.
All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future results. Diversification does not ensure a profit or protect against a loss.