No doubt, more investors are asking this question following the release over the past week of the September quarter Consumer Price Index (CPI) showing below-expectation inflation. These statistics provide yet another reminder of the realities of the prevailing economic and investment environment.

Income-focused investors, particularly retirees, are among the most vulnerable to making knee-jerk investment decisions in response to the challenges of a low-interest, lower-return investment climate.

Such investors may be more tempted to try to prop-up their incomes by reducing their exposure to high-quality fixed interest and broad share portfolios to increasing their allocations to higher-risk bonds and more concentrated high-yield share portfolios.

Past research papers by Vanguard in the US - including Required or desired returns? That is the question and Total return investing: An enduring solution for low yields - have suggested a couple of ways to help investors deal with difficult investment outlooks:

• Take a total-return investing approach: This involves investing for both cash flow and capital appreciation. Under a total-return approach, investors needing more income to finance their lifestyles than generated by their portfolios draw down against their portfolio's capital appreciation.
• Set realistic expectations for your future portfolio returns: With unrealistic expectations, investors may more easily fall into such traps as taking excessive risks in an attempt to boost returns, chasing last year's investment winners and making short-term, emotionally-driven investment decisions.

Vanguard's Investment Strategy Group conducts extensive modelling in Australia and overseas - using the Vanguard Capital Markets Model - to produce realistic and "reasonable return expectations" for major investment asset classes over the long term.

The group's present modelling suggests that Australian investors are likely to experience below long-term average returns from global shares and global fixed interest over the next 10 years or so.

By combining a total-return investing approach with the setting of realistic expectations for your returns, investors can concentrate on fundamentals of what makes a sound investment portfolio.

These fundamentals, which are largely under an investor's control, include: setting an appropriate target asset allocation and investment diversity for your portfolio, minimising investment costs, efficiently managing tax and remaining focused on your long-term goals.

Significantly, combining a total-return approach with realistic investment expectations enables investors to focus on their overall portfolios instead of being side-tracked by what's happening in part of the portfolio - such as the income side.
 

By Robin Bowerman
Smart Investing 
Principal & Head of Retail, Vanguard Investments Australia
02 November 2015