The same need exists in retirement. But in both situations, focusing excessively on income can be a mistake. For example, taking the job that pays the most may lead you to choose work you don’t like or fail to consider your desired lifestyle.
In retirement, overemphasising income-producing investments can also lead to costly errors. Proof of these risks surfaced again a few weeks ago when — for the second time in a year — U.S. industrial giant General Electric slashed its quarterly dividend from 12 cents to 1 cent following news of a criminal accounting probe.
It’s often difficult to break the habit of fixating on income. We spend our working years trying to amass enough to retire. Our minds concentrate on a number — $1 million, for example — that will allow us to stop working. Psychologically, it becomes challenging to shift to spending that money, so many retirees try to live off portfolio income only.
History also encourages an income focus. When interest rates were high, many retirees could count on interest and dividends to pay their bills without dipping into principal. But as interest rates declined, so did income. In the last decade, the yield on a globally diversified portfolio split evenly between shares and bonds fell from nearly 5 per cent to 2.5 per cent, a 50 per cent decline in income, according to Vanguard research.
Investors may try to close this gap by overweighting income-producing or defensive assets, but let’s look at how these strategies can unwittingly increase risk:
Moving money from fixed income into shares that pay high dividends. This choice can increase portfolio volatility for a simple reason: Shares are riskier than bonds. When share prices fall, investment-grade bonds tend to rise in value, cushioning a portfolio. Also, shares that pay higher dividends tend to be value, as opposed to growth, shares and are concentrated in certain industries, such as financials. As a result, boosting allocations of dividend-paying stocks can reduce diversification and increase vulnerability to sector downturns — exactly the opposite of what the investor hopes to achieve.
Replacing investment-grade bonds with higher-yielding bonds. Higher-yielding bonds can be as volatile as shares, so this strategy also sacrifices downside protection for the potential of higher income. Bonds that pay above-average rates of interest are riskier credits. That’s why they are often called junk bonds. During periods of economic turmoil, default rates on lower-quality bonds increase, causing them to fall in value, often in tandem with shares.
Overweighting term deposits and cash while underweighting bonds. Shifting money toward safe bank accounts is tempting. But while term deposits and cash protect principal, they don’t offer capital appreciation in troubled times. When interest rates fall, bank deposits usually earn less money, but investment-grade bonds often increase in value, providing reassuring ballast when shares decline.
The pitfalls of these choices are many, which is why we advocate a total-return strategy, which involves creating a diversified portfolio in line with your financial goals. That way, you base withdrawal amounts on income and capital appreciation.
Compared to the income approach, total-return investing gives you flexibility. You can adjust spending and withdrawals based on overall portfolio growth instead of depending only on the income the investments yield. Total-return investors avoid the downsides of overemphasising income and enhance their ability to reach their goals.
Many investors can benefit from getting professional advice when making these decisions. If you’re looking to learn more about total-return investing, our paper, “From assets to income: A goals-based approach to retirement spending”, can help.
Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
13 November 2018
For more than 20 years, Sam has been a financial planner helping individuals and families achieve their financial planning goals, by providing advice on Investment Planning; Insurance Planning; Tax Planning; Retirement Planning; and Estate Planning. Working with a network of highly skilled professionals in Sydney he is dedicated to providing high-quality advice and integrated wealth management solutions that simplify and enhance the quality of his clients' lives.
Sam established his own firm in 1997 and has overseen its steady development and growth. Attention to detail, good listening skills and great empathy are symbols of his appreciation by his clients. He has built long-term relationships with his growing client base and aims to provide excellent customer service.
Sam began his financial planning career in 1993 after completing a Bachelor of Science degree in 1991. Since this time he has accumulated many professional qualifications such as:
Sam has volunteered with the Cancer Council of NSW and can be seen almost every year volunteering or participating in the 7 bridges walk.
Away from the business, he enjoys spending weekends with his son. He is also a football (soccer) tragic and is a massive Chelsea FC fan.
Having worked for national financial planning companies in the past, George has extensive experience in the provision of advice in risk insurance, investments and retirement planning and is focused on forming long-term relationships with his clients.
George has been awarded a Masters of Commerce (Financial Planning) and a Bachelor of Commerce through University of Western Sydney as well as having the Diploma of Financial Services (Financial Planning).
Jane Lim is a friendly character with a bubbly personality. She has the unique ability of making complex information sound simple and easy to digest.
Jane entered the financial services industry in 2006, and worked with big blue-chip financial companies such as Count Financial Limited and AMP Financial Planning Pty Ltd.
She holds a Master's degree in Applied Finance through Macquarie University, and she is a member of the Million Dollar Round Table.
Being a self-confessed "tennis nut", Jane spends many weeknights in the tennis court, and is a frequent member of Sydney's Eastern Suburbs Tennis Competition.
Being a highly motivated professional, Jane is always eager to help her clients on a wide range of financial planning needs.
Paul has been a financial planner for over 15 years helping individuals and families successfully achieve their financial planning goals. He is very focused on building successful long-term harmonious relationships with his clients.
He provides a holistic approach on various aspects of financial advice encompassing areas such as Investment Planning; Insurance Planning; Tax Planning; Retirement Planning and has extensive experience and knowledge in these fields.
Paul's professional qualifications are:
Away from his professional life, he enjoys spending his time with his family doing various activities such as coaching his son and taking him to games. He is a very avid sports fan and a cricket enthusiast.
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Christian joined Capitalwise as Client Services Manager, with backgrounds in both customer service and administration.
Christian is passionate in providing excellent customer service by being attentive to client’s need as well as being able to circumnavigate challenges.
He holds a Master's degree in Commerce specialising in Marketing through the University of New South Wales.
Volunteering is one of his delights in life, where he had spent time being involved with the Centre for Volunteering, St Vincent de Paul's Society, and Sculpture by the Sea in a variety of positions.
Jenny is a University of New South Wales graduate who joined the team as an Administration Assistant. She is keen to put her customer service and organisational skills to use, making sure day to day operations run as smoothly as possible.
Outside of work, Jenny focuses her efforts on karate and ice hockey. She can often be found coaching and practicing karate at her alma mater. The rest of her time is spent at one of Sydney’s many ice rinks playing, practicing, or officiating ice hockey.
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