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Retirement planning: income vs capital growth

Retirement planning: income vs capital growth

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When it comes to the motivation behind investing, we all have different reasons.

A recent study of investors by BetaShares, found that Australians have widely varying expectations and goals for our investment portfolios. While not unexpectedly, more than 85% of us say growing our wealth is our primary objective, the reasoning behind that decision is split. Almost evenly, Australians claim to grow their wealth for two reasons: their retirement and income.

Investors sometimes perceive that growing wealth and generating income are mutually exclusive: that is, a focus on ‘growth’ means forgoing ‘income’, and a focus on generating income means sacrificing growth. In particular, investors relying on their portfolios for income to support their lifestyle (‘retirees’ for example) will often make portfolio construction tailored to income a primary requirement.

At Gilkison Group, we believe that an “income-only” focus create increased risk in a portfolio and limits its potential for capital growth. As such, we are strong proponents of the concept of ‘total return’ investing – or investing for cash flow and capital appreciation. Instead of constructing a portfolio to align income yield with spending requirements, a total return approach aims to align the portfolio’s total asset allocation with the investors spending goals and risk tolerance.

This approach advocates keeping your portfolio broadly diversified at a low cost and focused on the overall, or total, return. Where the need for additional income occurs over and above the yield generated by this broadly diversified portfolio, the investor spends the amount made from the overall portfolio – or the total return – rather than switching around holdings to generate additional yield.

Two key reasons we believe the total return approach may be more beneficial to the long-term health of your investment portfolio are:

  1. Lack of diversification – Being too focused on the income yield of the portfolio can mean missing out on the importance of portfolio diversification across different sectors and asset classes and lead to a more heavily ‘concentrated’ portfolio with higher risk sand less reliable investment outcomes.
  1. Being forced to live more frugally – If the portfolio income yield falls short of actual spending requirements, it may result in retirees ‘underspending’ from their portfolio and living an unnecessarily frugal retirement.

We understand that many Australians have a ‘behavioural bias’ towards income. This bias is accentuated by our system of dividend imputation and the lure of franking credits. However, we also believe that making income the primary objective can put people at the mercy of factors outside their control, can leave them exposed to stock-specific and industry-specific risks and can mean they miss out on opportunities elsewhere.

The way we help our clients is by continually bringing their attention back to the broad objectives of their portfolios, reminding them of the advantages of taking no further risk than is required to meet those objectives and emphasising the flexibility and control enabled by putting the focus on cash flow rather than income.

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