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Tips for the successful investor

24 Jun 2013

Investors often face a dilemma when investing their money due to the trade-off between income and capital growth. 

Constructing a portfolio for current income involves determining the required income level and then acquiring a blend of cash, bonds, real estate and equities which will generate the required income – cash, bonds and real estate providing a reliable high income – equities, enabling the income to grow.

Typically, there are investments which provide a high level of income, such as bonds and cash, but which have less scope for capital growth. Conversely there are investments which produce a low level of income but have an ability to grow that income, and thus enjoy good capital growth over time. Choosing between these investments can be difficult. 

Marriott Asset Management says a potential solution to this dilemma is to adopt a balanced approach, blending different asset classes to achieve one’s objective – a trend which they notice is on the rise at present.  

"By combining high yielding investments (i.e. bonds) with investments that have the ability to grow their income (i.e. equities), it is possible for an investor to attain a reasonable level of income with inflation-hedged income and capital growth. The income can be used to fund a lifestyle or can be reinvested to accumulate more capital." 

Marriott Asset Management has the following advice for investors: 

For balanced mandate success: invest for income and the capital will take care of itself

Although capital growth receives a great deal of investor attention, investing is ultimately all about income. Retired investors invest to generate an income stream while pre-retirement investors invest to provide for their future income needs. Investors therefore need to consider two aspects: current income needs and future income needs, each of which will have different influences on their portfolio decisions. 

Investing for current income

An investment portfolio providing for current income needs, such as a living annuity, should ideally provide this income without eroding capital. Capital erosion occurs when an investor draws more income than the income produced by the investments. By eroding capital an investor reduces future income, so it is vital in the early stages of retirement that capital is preserved as far as possible. Capital preservation can be achieved by selecting investments that produce the desired income yield. 

Constructing a portfolio for current income involves determining the required income level and then acquiring a blend of cash, bonds, real estate and equities which will generate the required income – cash, bonds and real estate providing a reliable high income – equities, enabling the income to grow. Crucially, the choice of equities should include only those which generate a reliable, growing income stream.

Investing for future income

Where income is not an immediate need, investment decisions are driven by a need to maximize investment value upon retirement. This can be achieved by: 

  • Capital accumulation – When income is not required to fund a lifestyle it should be reinvested. Reinvesting income will increase an investor’s capital base which will in turn produce more income to reinvest. This increases the size of your portfolio over time.
     
  • Capital value growth – The value of a company grows over time at the rate at which its profits grows. In the same way, the value of an investment grows over time at the rate at which its income grows. Therefore investments that grow their income will increase the value of your portfolio over time.

Constructing a portfolio for future income involves determining an investor’s risk tolerance and recognising that investment risk lies with income growth. Unlike income yield, which is known at the time of investment, income growth is less predictable. Therefore, capital accumulation by re-investing income is a more certain and predictable way of increasing the size of an investment. Over the longer term, however, capital value growth resulting from income growth will generally produce a greater increase in investment value. 

Although capital growth receives a great deal of investor attention, investing is ultimately all about income. Marriott’s advice for investors: the best route to achieve success in a balanced mandate is to focus on income and let the capital take care of itself. 

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