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Income versus total return

Christine Benz  |  03 Dec 2015Text size  Decrease  Increase  |  
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Christine Benz is Morningstar's US-based director of personal finance. This article originally appeared on the Morningstar US website.


Just as partisan bickering has stalled legislators' effectiveness, so do investment absolutists have the potential to derail productive investment debate.

Morningstar's president of fund research, Don Phillips, has discussed this phenomenon in the realm of indexing versus active fund management, writing that extremists on either side of the debate routinely ignore legitimate data simply because it doesn't support their views.


Not as different as you think

Lately, I've seen signs of the same absolutism in the realm of another great investing debate: whether to manage a portfolio for income or total return.

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This is frustrating because when you take the time to examine the two approaches, it's clear that they're not polar opposites at all. By getting bogged down in semantics, I fear that some investors might miss the big picture.

For starters, no one's saying income generation shouldn't be a key goal for every investor; it is, after all, one of two key components of the total-return equation. (The other, obviously, is price appreciation.)

So when I recommend a total-return approach, I'm not saying to gorge yourself exclusively on securities with growth potential but no ability to "show investors the money". (We saw the downside of such strategies during the late 1990s, and it wasn't pretty.)

Income producers--whether bonds or dividend-paying stocks--should clearly be an important component of every investor's toolkit. They should also, arguably, grow in importance as a percentage of our portfolios as we age: Focusing on securities with the ability to pay income adds a valuable quality overlay to a portfolio, as income production can be an important show of an entity's financial wherewithal.

From a practical standpoint, income can also provide a cushion on the downside when the market is falling.

Moreover, what would seem to be another big ideological fissure between the "incomeniks" and the "totalniks"--whether you tap your principal or not--is not as big a division as it might seem.

True, the goal for many income investors is to not touch principal but rather to fund expenses with the income that their portfolios generate. By contrast, total-return investors don't reflexively avoid tapping capital to fund living expenses; retired total-return investors might employ a bucket approach that relies on spending both income distributions and rebalancing proceeds.

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