Both income and capital growth are important aspects of investing, but they can serve different purposes when part of a well thought out strategy, which is prioritised based on your needs, objectives, and circumstances.
We love investment income at SFP, because it adds real money to your investment account which you can use in the real world. Don’t get me wrong, capital growth is great (both the income and capital are important considerations for any investment), however, until you sell something it’s not real money we can use at the shops. And the problem with selling investments is that we then have to give up the future income from it. A bit of a conundrum.
They say, “horses for courses”. Depending on what life stage you’re in will depend on what investment return you might be favouring. Our accumulator clients might be focusing more on capital growth, whereas our retired clients might be more focused on a growing income from their investments.
Investment income may come in the form of interest, rent, dividends or distributions (as they call them from managed funds). The quality of the income is determined by the quality of the underlying investment, with consistency and reliability being two important factors we deem to be represented in quality income. The other important factor is the ability for the income to increase over time.
If you’re accumulating wealth over the longer-term, your focus is likely to be on capital growth, with income generated from that investment being used to purchase additional investments. However, there comes a point in time where your capital has grown sufficiently, and now your focus will be more on generating income to support your lifestyle.
If you need to access capital to fund your lifestyle expenses, you become a forced seller and must accept what the market gives you. This is generally not a situation many of our accumulator clients have dealt with, as we can set a retirement target date and plan accordingly, so we know when we’re likely going to need to access our investment capital.
The greatest challenge is for our pre-retiree or retiree clients, in that they may be in a situation where they have insufficient cash to fund their next pension payment. If the underlying investments produce sufficient income to top-up your cash account, then you won’t need to sell assets to fund your withdrawals, which is an ideal scenario.
This is where having a well-defined strategy comes into play, and why it forms an important part of our planning process for clients in retirement, or close to retirement. By looking ahead, we can determine the optimal timing for adjusting your investment strategy, as well as consider appropriate underlying investments to meet your needs going forward.
Re-investing dividends provides the opportunity to grow your portfolio at a greater pace over time, compared to banking your dividends. This applies regardless of whether you’re putting additional funds in or not, the dividends will be used to purchase more shares or units in your portfolio. This is known as “compounding returns”.
Where your strategy is largely to build your portfolio over a long period of time and your personal circumstances enable this to happen consistently (generally while you’re working) then re-investing dividends has proven to be an effective strategy.
However, if you require a regular income from your investments (such as in retirement), your dividends may be better served being directed to your cash or transaction account. This will in effect ‘top up’ your cash account and allow you to continue funding your income needs.
The decision to re-invest income, or allocate income to cash, really depends on your overall needs and there may be a combination of both of these approaches built into your overall plan.
Article by Steven Stolle
Director | Senior Associate
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General Disclaimer: This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. Please seek personal financial advice prior to acting on this information.