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Total return investment: A higher method for income investors


In the current low-yield environment, income-oriented investors may be tempted to search for high-yield assets to support their spending needs. However, according to a recently updated paper from the Vanguard Investment Strategy Group (ISG), Total return investment: A smart response to shrink yields, Many investors seeking income will be better served if they adopt a total return strategy that they spend on capital returns in addition to the return on portfolio income.

“The total-return approach allows investors to meet their spending needs without relying solely on portfolio yields,” said Jacob Bapp of Vanguard ISG, who created the new work based on Vanguard research with David Pakula, Ankul Daga and Andrew S. Clark. By Jaconetti, Francis M. Kinari Jr., and Christopher B. Phillips. “It addresses portfolio building in an holistic way, asset allocation is determined by the investor’s risk-return profile.”

After the Covid-1 pandemic epidemic hit the financial markets in March 2020, fixed-income investments have already yielded low yields. The lowest, 10-year Treasury note of 2020 produced 0.52%, a fraction of its historical level.

“The low-yield environment creates a challenge for income-centric investors, who expect to use the portfolio for income expenditures,” said Mi Bu Baap. “Today, a broadly diversified portfolio of equity and fixed income can no longer yield a return equal to 4% of the portfolio value, consistent with conventional guidelines for spending from a portfolio” (Figure 1).

Figure 1. Yield of the traditional strategic asset class falls below the 4% spending target

Note: Yield from January 1.1990. August 1. Until 2020. The asset class and their representative indicators are: Bloomberg Barclays Global Aggregate Index USD Hedged for Global Bonds; For US bonds. Bloomberg Barclays US Overall Index; For global equities, the MSCI World Index USD; And for US equity. MSCI USA Index. The balanced portfolio consists of an index of US bonds (35%) and global bonds (15%). US equity (30%), and global equity (20%).
Source: Vanguard calculations using data from Thomson Reuters datastream.

Past performance is no guarantee of future income. The performance of an index is not an accurate representation of a particular investment, as you cannot invest directly in an index.

Advantages and Challenges of Traditional Income Strategies

An income-oriented approach is preferred by investors to maintain the longevity of the portfolio. Expenditure is directly dependent on the yield of the portfolio, so complex spending strategies are not required.

To meet current spending requirements in the current low-yield environment, many income investors need to adjust their asset allocation. But as the paper points out, these income-seeking strategies come with considerable risk, including more focus on dividend-centric equities and more exposure to high-yield fixed-income investments that behave like equities. Strategies like these, which reach for yield, often lead to higher volatility. (Figure 2)

Figure 2. Look at the high yielding asset class

While the high-yield asset class may appeal to income investors in the current low-yield environment, they carry considerable risk.  This table examines the application and risks of the following high-yield asset classes - high-yield bonds, emerging market bonds, long-term bonds, REITs, and high-dividend-paying equities.  These asset classes often yield high yields, but they carry considerable risk with greater volatility and less diversification due to the tendency to act as equities.
Source: Vanguard.

“Leaning a portfolio toward high-yield assets and staying away from the traditional strategic asset class only increases the amount of losses during market pressures, including the recent 2020 market changes,” Mr. The father said (Fig.)).

Figure High. High yielding resources carry additional negative risks in the early stages of an epidemic

This time the chart shows both the maximum drawdown and the growing total return for the high yielding asset class and benchmark portfolios, in the early stages of the epidemic, from February 3, 2020 to March 31, 2020.  For the high yielding asset class, the global REIT had the highest draw-down - 49.6% and total return36.7%.  Global High-Dividend Equity had the highest draw-down - 33.1% and total return20.1%.  By comparison, the largest draw in the global diversified equity benchmark portfolio was a total return of 33.90% droid and cum21.07%.  Next we can look at high yielding fixed income materials.  The highest draw-downs of global high-yield bonds were –22.8% and total additions of cum16.5%.  The highest draw-down of emerging-market bonds was –16.4% and total return 11.8%.  Long-term fixed income had the highest draw24.6% drawdown and cum8.4% cumulative total return.  By comparison, the worldwide diversified fixed income benchmark portfolio had only a small maximum draw of -5.45% and an aggregate total return of cum1.05%.  Balanced portfolio had 50% global diversified equity and 50% global diversified fixed income maximum draw19.68% drawdown and total return of cum 11.06%.  High-yielding equities and bonds carry additional negative risks, both in terms of maximum drawdown and increasing total returns, compared to a high-yielding benchmark portfolio.
Note: Return February from February, 2020 to March1, 2020. The asset classes and their representative indicators are: Global REITs, for MSCI ACWI Diversified REIT Index; For emerging market bonds, Bloomberg Barclays EM Aggregate Index; For global high-dividend equities, the MSCI World High Dividend Yield Index; For global high-yield bonds, Bloomberg Barclays Global High Yield Index; For long-term fixed income, Bloomberg Barclays Long US Corporate Index; For globally diversified equities, the MSCI AC World Index; For the worldwide diversified fixed income, Bloomberg Barclays Global Aggregate Index Hedged; And for a balanced portfolio, 50% equity / 50% bond allocation from MSCI AC World Index and Bloomberg Barclays Global Aggregate Index Hedge. All indexes are in USD.
Source: Vanguard calculations using data from Thomas Reuters datastream.

Past performance is no guarantee of future income. The performance of an index is not an accurate representation of a particular investment, as you cannot invest directly in an index.

Total return investment: A good method

Mr. The benefits of a varied total-return approach have also been explored in Baap’s research.

In contrast to traditional theoretical income strategies, the total-return method generates income from capital gains in addition to portfolio yields. This approach begins with the creation of a diversified portfolio in conjunction with investor risk tolerance (Figure 4).

When combined with a prudent spending rule, a total-return investment strategy has several advantages over a return method:

  • Portfolio diversity. Total return strategies are much more diverse across asset classes. Diversified portfolios are less volatile and hold up better during stock market shocks.
  • Tax efficiency. With the total-return system, investors can pay less tax because some of their payments come from capital gains, which are taxed at a lower rate than income.
  • More control over the size and timing of portfolio lifting. With a total-return strategy, investors can have peace of mind because they can spend from capital gains in addition to portfolio yields. Numerous studies have shown that if you follow an orderly withdrawal plan under a total-return strategy, your savings can last for several years.

Figure 4. Total return method vs. income method

This figure compares the total return approach with the income-centric approach to portfolio building.  The total return process begins with the investor’s goal and risk tolerance, which then informs the asset distribution and then the investor can spend permanently from both the yield and the capital return.  The method of income begins with the investor’s yield target, which informs the asset allocation;  However, it can be an inappropriate risk exposure.  The return method does not start with the investor’s risk tolerance and goal and can lead to unintentional portfolio risk exposure.  To show the difference in the process of total return method compared to the content income method.
Source: Vanguard.

– Eligible dividends are taxed at the rate of capital gains tax, which is lower than the federal marginal income tax rate.

“A full-return approach can help reduce portfolio risk and maintain portfolio longevity, while allowing an investor to meet spending targets in a combination of portfolio income and capital,” said Mi Bu Baap. “We strongly recommend this approach, especially during this period of prolonged low yields.”


Comments:

All investments are at risk, including the potential loss of money you invest. Be aware that fluctuations in financial markets and other factors can reduce the value of your account. There is no guarantee that any specific asset allocation or combination of funds will meet your investment objectives or give you a certain income level. Diversity does not guarantee gain or protect from loss.

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