For retirees relying on their hard-earned savings to meet income needs, these may feel like uncertain times. Interest payments from traditional fixed income investments (bonds) are at historical lows, depressing the cash flow created by an income-oriented portfolio.
As a result, many investors have flocked to high dividend-paying stocks, which now yield more than 10-year government bonds. In our view, such short-term pursuits of income create excessive risks for which retirees are unlikely to be rewarded.
While dividend-paying stocks play an important role in a well-diversified portfolio, they behave quite differently than bonds. A singular focus on income-producing stocks subjects retirees to a wildly different experience than for which they’re likely suited. Most folks simply cannot stomach the increased volatility of an all-stock portfolio. Remember 2008? That single year, the same dividend-payers folks are piling into today lost half their value.
A total return approach based on a well-diversified and asset-allocated portfolio helps shield investors from these risks. It relies on multiple asset classes to generate cash flow: Dividends (from stocks and REITs), interest (from bonds), capital gains and the occasional return of principal (each from asset sales).
What’s more, cash flow under a total return approach can be reliably generated regardless of the current market environment. When stocks are performing well, gains from prudently paring them back supplement the income from interest and dividends. When stocks struggle and bond prices surge, bonds can be sold at relatively high prices. If not used for spending, the excess cash-flow can be re-allocated to whichever asset class is lagging at the time. And that follows the golden rule of investing: “Buy low, sell high.”
A total return approach reliably balances risk and return while providing income. It is this reliability which helps investors focus on the long-term, protecting them from making drastic—and inadvisable—shifts in asset allocation.
Giving up on bonds (when yields are low) and piling into dividend-paying stocks (when stock yields are high) is just one of many strategies which trades short-term reward for long-term risk.
A balanced, total return approach best enables a portfolio to meet spending needs now and throughout retirement.
