The purpose of this series of posts is to demonstrate why we believe a total return approach is a better option than a pure income approach when investing to fund living expenses, particularly in today’s low-interest-rate environment. We hope that convincing investors of this will pay them dividends in the form of better returns.
In part 1 of 4, we considered some of the pitfalls of investing in vehicles that primarily cast off income. Let’s consider one more pitfall here-RISK.
The risk side of the equation is of particular concern. Over the years, there have been many examples of products introduced by investment firms that were designed to generate high income returns that subsequently “blew up,” suffering losses far above what investors expected or could tolerate relative to their goals. (Just look back to 2008 and the dismal returns of some so-called lower-risk short-maturity income funds.) Today, some of the popular ideas—and ones on which we’ve gotten many questions—are non-traded REITs, MLPs (Master Limited Partnerships), closed-end bond funds, annuities, and flexible bond funds that take on various types of risk, including credit risk or interest-rate risk. While these may have a legitimate place in a portfolio, they need to be evaluated in a broader portfolio context that takes into account an investor’s goals and risk tolerance as well as other investment opportunities available at the time.
In the current environment of very low bond yields, we’ve seen too many examples of investors shifting away from bonds toward higher-income investments that present very different risk profiles.
An investor might cite income as a goal. But what that investor typically means is they are in withdrawal mode and require cash flow from their portfolio to fund living expenses. What really matters is having a sustainable withdrawal plan to determine how much they can realistically take out over time.
Our approach has always been to try to generate the highest return without exceeding a client’s risk tolerance. Having considered some pitfalls and risks associated with portfolios limited to investments that cast off income, Part 3 will summarize reasons to build portfolios with risk and return, as opposed to income, as a primary focus.
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