Income generation is a priority for many investors. Years have passed since sitting back and collecting interest made it a simple task. Let’s look at common approaches.
Yield vs. Total Return
Many investors, including retirees, rely on their investment portfolio to fund their cash needs. One approach is to simply draw on interest and dividends from securities as earned without touching principal.
Low-yields have driven investors to increase credit risk on bond holdings and/or overweight dividend paying stocks at price of diversification.
The total return approach involves selling assets in the portfolio to synthetically create cash flow. It makes little difference if the returns are delivered as dividends or capital gains. Greater control over cash flow generation results because it does not depend on how total returns are split between yield and capital appreciation. Note: tax consequences may vary.
Managing risk through diversification is important. It’s just not prudent to put all your eggs in one basket.
Holding a portfolio that emphasizes dividend-paying stocks adds risk. A global portfolio of dividend-paying stocks would have similar average returns to a portfolio of nondividend-paying stocks but would be excluding 35%-40% of stocks globally, resulting in lower diversification. Also, dividends are not guaranteed and the number of firms that pay them is shrinking. (Black, Stanley. March 2013 DFA white paper.)
Let me know if you have any questions or need any additional resources. Special thanks to Dimensional Fund Advisors for their contribution to this.
Until next week,
Susan R. Linkous, AIF
The Linkous Group, Ltd.
A Registered Investment Advisor