Combining total-return investing with realistic investment expectations

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