Why you don't have to choose between growth and income

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When it comes to the motivation behind investing, we all have different reasons.

A recent study of investors by BetaShares, found that Australians have widely varying expectations and goals for our investment portfolios. While - not unexpectedly - more than 85% of us say growing our wealth is our primary objective, the reasoning behind that decision is split. Almost evenly, Australians claim to grow their wealth for two reasons: their retirement and income.

Investors sometimes perceive that growing wealth and generating income are mutually exclusive: that is, a focus on growth means forgoing income, and a focus on generating income means sacrificing growth. This makes portfolio construction tailored to growth or income a primary requirement.

growth v income investing portfolio

This is the investment oxymoron.

However, it doesn't need to be this way. To some degree, we can have our cake and eat it too, bypassing the investment oxymoron and working towards multiple objectives.

Under the right framework, we can manage the balance between growth and income, using not just portfolio construction, but appropriate portfolio management. Investors can then focus on maximising their total investment return (based on their personal circumstances and risk appetite) without letting the growth-income oxymoron interfere.

The total return of any investment portfolio can be broken into capital gains and income. In the absence of tax effects, the investor should be agnostic as to how returns are generated.

For the same total return, whether it is derived from capital gains, income or a combination is unimportant. When tax is included, the same applies, just to after-tax total returns, (derived from after-tax income and after-tax realised capital gains).

This is important, because the same portfolio can generate different levels of income or growth through strategic management. In an after-tax framework, income and growth in a portfolio can be used to generate gains or income for the investor. After-tax income can be reinvested to add to the value of a portfolio and generate gains over time.

Alternatively, income - traditionally derived from the income from individual constituents - can be supplemented by strategically selling down parts of a portfolio.

Understanding this allows an investor to tailor the growth or income profile of a portfolio - not only by using the growth or income attributes of the portfolio constituents - but by strategically managing reinvestment of income or selling down its assets.

The primary objective for income generation should be high after-tax total returns, with income coming from both portfolio constituents, supplemented by selling down parts of the portfolio.

Similarly, a portfolio with a growth objective should also target high total returns, then reinvest income to allow for the benefit of compounding.

In this framework, investors can focus on constructing portfolios tailored to their specific situation, rather than making growth or income the primary driver. Instead, they can focus on overall levels of risk, time horizons and external factors like an emergency or change in their personal circumstances.

This doesn't mean that the growth or income attributes of portfolio constituents should be ignored, but that investors should understand that they have a degree of flexibility - independent from the growth or income attributes of portfolio components - to achieve their growth or income objectives.

Investors in different circumstances and at different stages in their investment journey tend to focus on growth or income in specific ways. Understanding how both these outcomes are achieved on an after-tax basis, and understanding how growth can feed into an income-generating portfolio and income can be reinvested for growth, means that the primary objective - growing wealth - can be maximised without either growth or income dominating decision making.

Investors can then consider their specific situation, risk appetite and needs and choose investments that aim to maximise total portfolio returns.

Rather than being an oxymoron, together growth and income are just portfolio attributes that can work together to grow wealth - either as income or as gains.

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Dr Cohen is a senior investment specialist with BetaShares. He is a senior adviser with special interests in the Australian retirement income system, and in understanding investor behaviour. Dr Cohen is part of the founding team and continues as an advisor to BetaShares, where his focus is on product development. He lectures on risk management at the University of Sydney and is a senior adviser to the Centre for Financial Studies at Monash University.