Thinking Differently About Income: Focus Foremost On Total Return Investors and business owners continue to struggle with generating income in this low-interest environment. Traditional savings products no longer generate desired income, with yields on most fixed income products below inflation. This is clear from questions we continue to receive from businesses owners who are considering selling their businesses or have sold. In advance of a sale, they ask questions such as, “What do I need to sell my company for before taxes to generate sustainable cash flow?” After the sale, the questions mirror this concern: “Now that I have sold my business, will I be able to generate enough income to replace the cash flow I had from my company?” Given these top-of-mind concerns, many incomeseeking investors desire a portfolio that is focused more on yield than on capital appreciation. Much of the focus on yield enhancement stems from a common misconception that higher yields offer downside protection to a portfolio via the income offsetting the impact of a falling stock price on the portfolio. But this is not the case. The regular income generated by a high-yielding portfolio is not a “free lunch,” so to speak. When the company pays out cash, the market value of the capital base falls by a commensurate amount.
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2021 C A PI TA L M A R K E T S F O R EC A S T
In addition to the perceived shock absorber effects of yield, some investors desire yield for the stability provided by the “certainty” of income. However, while such a yield level was riskless years ago, it is no longer available in an environment with a 10-year Treasury rate of 1%. Even worse than the nominal yield, real yields (i.e., nominal yields less inflation) have compressed to 0% and, in some cases, have gone negative. In today’s world, because this income availability is relatively non-existent, investors have two options: 1) invest in higher-yielding assets to obtain the level of absolute yield required to meet desired (or, in the case of foundations, regulatorily required) spending needs, or 2) supplement yield with capital appreciation. The former option leads to investors taking on more risk than desired, which often contrasts with other portfolio goals. The latter allows client to create their own streams of income while regularly rebalancing their portfolios. Of course, if the low interest rate dynamic reverses as interest rates move higher, then investors can tilt portfolios back toward more yield and reduce the emphasis on capital appreciation.
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