Income Isn’t Everything
Most people should invest for total return
It is common these days for investors who call Vanguard Group to ask, "What mutual funds do you have that produce income?"
The calls show many people only think of income as cash flow—such as the money generated by bond interest payments or stock dividends, says John Ameriks, who heads Vanguard's Investment Counseling and Research Group.
But with interest rates low and bond yields falling, "it's unlikely that your portfolio can generate as much pure income now as it did five or 10 years ago," says Mr. Ameriks. Most investors, he says, need to rely on a total-return strategy, or investing for cash flow and capital appreciation.
Total-return strategies aim for enough appreciation to make the money last a long time. Whether they succeed depends on key variables, including how much an investor withdraws.
Funds that pursue a total-return strategy are more common than not. Even the types in the accompanying article—and which investors are buying for income—are typically managed with an eye to total return.
One important advantage of a total-return strategy is that it makes it easier to spread risk. If you don't require all your holdings to pay out significant current income, you can add many types of stocks and other securities to the mix.
That is valuable in part because bonds appear to be at the tail end of a 30-year bull market, and most bonds provide no protection against inflation. Stocks offer some inflation insurance, because under most circumstances, their prices will appreciate along with economic growth. Some also provide rising dividends.
"In this environment, building a total-return-oriented portfolio, where there is some current income but you also are getting appreciation, is a much better approach," says Philip Wagner, a portfolio manager at the Bryn Mawr Trust unit of Bryn Mawr Bank Corp., in suburban Philadelphia.
Another reason conservative investors should think about total return rather than just income: In choosing holdings, they should always be balancing the potential income from securities against the risk of price declines that would offset or exceed the payouts. For instance, long-term bonds generally pay higher yields than short-term ones. But for any given rise in interest rates, they will fall much more sharply in price.
Stocks, of course, can tumble, too. "We aren't telling people to put all their money into stocks," Mr. Ameriks says. "But given where stocks and bonds are right now, if you blindly look for income, you may be leaving an opportunity on the table that looks relatively attractive."