Hungry for income? Choose carefully.
When you are working or looking for a job, it’s only natural to think about the size of your paycheck. After all, you need to pay your bills, and it always helps to have a little extra.
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
vanguardinvestments.com.au
Latest Newsletters
Hot Issues
- Aged care report goes to the heart of Australia’s tax debate
- Removed super no longer protected from creditors: court
- ATO investigating 16.5k SMSFs over valuation compliance
- The 2025 Financial Year Tax & Super Changes You Need to Know!
- Investment and economic outlook, March 2024
- The compounding benefits from reinvesting dividends
- Three things to consider when switching your super
- Oldest Buildings in the World.
- Illegal access nets $637 million
- Trustee decisions are at their own discretion: expert
- Regular reviews and safekeeping of documents vital: expert
- Latest stats back up research into SMSF longevity and returns: educator
- Investment and economic outlook, February 2024
- Planning financially for a career break
- Could your SMSF do with more diversification?
- Countries producing the most solar power by gigawatt hours
- Labor tweaks stage 3 tax cuts to make room for ‘middle Australia’
- Quarterly reporting regime means communication now paramount: expert
- Plan now to take advantage of 5-year carry forward rule: expert
- Why investors are firmly focused on interest rates
- Super literacy low for cash-strapped
- Four timeless principles for investing success
- Investment and economic outlook, January 2024
- Wheat Production by Country
- Time to start planning for stage 3 tax cuts: technical manager
- Millions of Australians lose by leaving savings in default MySuper funds
- Vanguard economic and market outlook for 2024: A return to sound money
- An investment year of ups and downs
- How to tame the market's skewness
- The Countries that Export the Most Wine in the World
- Tips for preparing for the best tax outcomes
Article archive
- October - December 2023
- July - September 2023
- April - June 2023
- January - March 2023
- October - December 2022
- July - September 2022
- April - June 2022
- January - March 2022
- October - December 2021
- July - September 2021
- April - June 2021
- January - March 2021
- October - December 2020
- July - September 2020
- April - June 2020
- January - March 2020
- October - December 2019
- July - September 2019
- April - June 2019
- January - March 2019
- October - December 2018
- July - September 2018
- April - June 2018
- January - March 2018
- October - December 2017
- July - September 2017
- April - June 2017
- January - March 2017
- October - December 2016
- July - September 2016
- April - June 2016
- January - March 2016
- October - December 2015
- July - September 2015
- April - June 2015
October - December 2018 archive
- Ranking of the world's best: Taking it personally
- The value of advice - Behavioural Coaching
- Our Advent calendar for 2018
- Compliance, tax advice in strongest demand from SMSFs
- Stop!! Don't do a paper Budget, use our online budgeting tools instead.
- Franking credit policy to dent retirement savings by 15 per cent
- Information needed to be the BBQ expert.
- Hungry for income? Choose carefully.
- Retiree self-protection: A volatility-and-downturn 'bucket'
- How financial advice helps create wealth.
- Superannuation gender gap narrowing, research shows
- All the stats you need to see how Australia is going.
- Market downturns, like this one, are to be expected
- ATO claws back $850m in unpaid SG in FY 17-18
- ‘Hefty penalties’ with TRIS payment failures, SMSFs warned
- The global financial crisis: Behind us but far from over
- 'Huge' professional risk in SG delays, big four firm warns
- What a financial adviser can add to your portfolio's returns.
- ATO updates crypto guidance
- Reverse mortgages: Short-term gain, long-term pain
- ATO set sights on 27,000 funds in ongoing crackdown
- ATO zones in on hundreds of newly created reserves
- A dynamic approach to retiree spending and drawdowns
- Your investment freedom-maker