Income vs total return in retirement: what's more important?

By Darren Beesley
BCom FIAA Co Portfolio Manager - Multi Asset Group Sydney, Australia

Investors and advisers’ mindset around post retirement investing is rapidly evolving. A wave of baby boomers with accumulated super balances are seeking retirement solutions and the asset management industry is developing its approaches in response.

The importance of yield has become deeply engrained into the psyche of post retirement investing. Through ‘income investing’ investors have sought yield in many asset classes including stocks, bonds and property. In some cases, however, it appears this is all investors in this space care for. It’s an obsession that can eclipse attention on the other side of the equation: capital growth.
Some advisers, consultants and academics are now calling out the risks of becoming too one dimensional in pursuing yield, because doing so at the expense of greater risk to capital can have dire consequences to long term wealth and income longevity.

There is no doubt that pursuing high yield investments can be dangerous, such stocks are often paying a high yield because their price has been pushed down by the market on poor performance. Similarly, high yielding corporate bonds are the most likely to default, high yield property is typically in low growth segments or facing risky redevelopments. Yes, going too far out on the income spectrum can be risky business.

We would, however, like to set the record straight on the fact that, whilst investing purely for yield can be dangerous, when it’s done correctly, and as part of a balanced approach, income investing into quality assets delivers three powerful benefits that means it should remain an important component of post-retirement investing.

1. Asset liability matching

The first benefit of income for retirement is that it makes intuitive sense. In theory, if you’ve got a continual need for cash flow from a set of assets, it makes sense for those assets to continually produce cash flow via dividends, coupon payments or rent. When cash flow in = cash flow out, investors have less need to trade the underlying units and sell them to fund the required cash flow, which means less hassle, less transaction costs, and less likelihood of needing to sell following a crash at low prices.

2. Tax treats
Income, secondly, delivers major tax benefits from franked dividends. As we’ve noted before, franked dividends are particularly beneficial for retirees on a 0% tax rate because it boosts their retirement income.

Investors who pay low tax actually get a cash payment for the difference between any franked rate of dividend income and their individual tax rate. For every 70 cents of dividends, investors can receive a tax credit of up to 30c, which equates to 43 cents per dollar of dividends. A retiree paying 0% tax gets that tax credit back as a cash payment. It is equal to a 43 per cent uplift on each dollar of fully franked dividends.

3. Behavioural benefits
But one of the most powerful outcomes is that income helps retirees stay the course during difficult markets, which is crucial in helping them meet their goals. Because income is effectively a ‘retirement salary’, and because income investors aren’t focused on the underlying volatility of their capital, income gives retirees the confidence to ‘look through’ what’s going on in the market. As long as they are getting income, volatility doesn’t matter as much.

The GFC illustrated the benefits of focusing on income as the goal rather than account balance. An equity investor focused on total returns would have witnessed their balance crashing 50 per cent. The psychological toll on retirees was terrible. They would have fretted about the need to sell and about their money running out. Many switched to cash at the worst possible time. Yet an income orientated investor with the same portfolio would have would have seen their income fall by only 24%, and could have adjusted their assumption accordingly.

Income vs total return in retirement: what's more important-image1
Income vs total return in retirement: what's more important-image 2

Source: AMP Capital

When retirees are invested in income, they receive a form of embedded advice. If the economy does go into recession, dividends get cut and income falls a little, they will have to cut their spending a little bit. That natural curb in spending when income falls lowers their chance of running out of money, can help the retiree’s money last longer, and therefore helps manage longevity risk.

Outside of equities, a retiree invested in a well-diversified multi-asset income portfolio receives additional stability and reassurance. Due to central banks using monetary policy as brakes on the economy, bond yields and cash rates tend to be higher when equity dividends are lower and vice versa. This gives multi-asset income portfolios excellent diversification across income sources, providing retirees greater confidence to stay the course during market turbulence.

Income vs total return in retirement: what's more important-image 3

Source: AMP Capital

The ability to ‘look through’ capital volatility is also contingent on having enough wealth to simply live off income. For those with lower wealth who will need to be continually selling assets to fund their retirement, capital volatility should be of greater importance. The faster a retiree intends on selling down capital to fund retirement, the greater they should focus on capital preservation over income generation.

A balanced approach
Ultimately, it’s all about balance. There are strong arguments for income investing, but this must be done in balance via quality assets that have resilient income streams and stability in capital value.
In a low-yield world, it has been perfectly rational for investors, particularly retirees, to focus on income-producing assets. Yet, as critics suggest, the hunt for income and an obsessive focus on returns from income can go too far.

But that doesn’t mean that we need to swing entirely the other way and ignore the benefits of income. What investors really need is a balanced outcome, or ‘resilient income’: that is, a stable income of between 4 and 6 per cent per annum, along with some growth to allow income to rise with the cost of living.

  • Goals-Based Investing
  • Income
  • Retirement
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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.


This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

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