It’s easy to become desensitised to the challenges facing others. We’re not living in their shoes, so we don’t experience their pain on a day to day basis. In a busy world it is easy to push these issues aside to focus on our own challenges.

It was only last week while discussing income investing with two wealth managers that the real problem facing retirees hit me. When I asked them for their return expectations on a ‘balanced’ portfolio, the response was a miserly “4.5 per cent”. That’s $45,000 a year based on a retirement lump sum of $1 million. 

I can assure you there aren’t that many people out there getting excited about 4.5%.

Chart: Falling rates are the source of major headaches for yield thirsty investors.

A rock and a hard place

In my view, investment advisers are stuck between a rock and a hard place. Expectations and requirements are for higher returns. However, investors are often unwilling to consider the downside risks that come with chasing higher returns. The situation is that advisers need to pitch portfolios with an expected return of 4.5% to provide enough protection on the downside. In recent history, returns have been better than that, but it won’t always be the case.

The other issue is that these advisers are heavily regulated for their own protection and for the protection of clients. They acknowledge the skinny returns, but I can understand why they don’t want to stick their necks out – there's literally no upside.

Some valuable lessons

Nonetheless, from the 60-minute discussion, I took away several points that I think investors would benefit from considering when putting together their strategy. If you don’t have time to watch the webinar, here are a few that stood out for me.

1) Go for total return, not just yield

Returns from investing come from both capital appreciation and income (dividends or distributions). You should consider both as a source of returns and don’t just focus on the yield. This means being willing to sell some shares as you go along.

2) Anything but cash

Both investors advocated an allocation to cash of less than 5%, the average SMSF is running above 20% cash. Yes, it is providing some optionality, but it is also a massive drag, earning close to nothing in the current environment.

If having some cash helps you sleep at night, one suggestion was to carve out a set amount and keep it separate from your investment portfolio.

3) Know what you own

One thing is guaranteed – investors are going to be presented with more ‘high-yield’ opportunities in the months and years ahead. Nobody can magically roll out higher yields without taking more risk. There will be some genuine innovation where investors will get access to new markets. But for every good one, I’d guess there’ll be at least two duds.

Do yourself a huge favour, take the time to understand what you own. It often only takes 10 – 15 minutes to have a review of the PDS to see if it passes the sniff test.

4) Think outside the box

I think this was my favourite insight from the session, and it adds value on the returns side of the equation. You’re unlikely to get great value in popular trades or stocks. James Gerrish used the example of Telstra’s recent dividend cut to illustrate how perceived bad news can actually be good for investors. 

His point was that a sensible business decision by Telstra’s management improved the quality of the business. The market has subsequently been willing to pay more for Telstra shares.

5) Buy the future, not the past

This is a simple one but an easy mistake to make. Historical yields are not a reliable guide for future returns. A share price may have fallen due to underlying business issues, therefore, inflating the trailing yield on the stock. Alternatively, there may have been a special dividend that makes the historical yield look sweeter than it really is. 

Again, it comes down to knowing what you own and the importance of focusing on the earnings that will ultimately deliver your returns.

One final point on diversification

One reader asked if his strategy of selling down shares in Afterpay, which he had owned since the shares were $5, was a good one. It's at the extreme end of the spectrum, and I hope there is more in his portfolio than just one stock. However, it does raise the question of how much diversification is appropriate for you. Professionally managed portfolios are at the other end of the scale and are very well diversified. This makes them resilient in tough markets, but it also puts a limit on returns.

While, I would never advocate a single stock portfolio, I have been spending time thinking about what the right amount of diversification is for me. Maybe that’s a good starting point.

Building a diversified income strategy

If you missed the webinar I think it is worth checking out. A replay is now available and can be accessed on the link below.

Ian Croucher

I think that there is also an unrealistic expectation of retirees that their nest egg will be go up or at least be fully preserved after retirement. That's not how it's supposed to work. In fact $1M getting a safe 4.5% is fine for an income of if you acknowledge that you have to also dip into the capital and possibly (hopefully!) supplement at the very end with age pension.

James Marlay

Good point Ian - I've also heard similar arguments about who retirees manage their property and the merits of downsizing as requirements change.

Linda Teller

Thank you for the article! When we talk about "return" we mean both income and capital appreciation, don't we? In case of the hypothetical retiree, trying to live of $1M invested at 4.5%, she still needs to sell some portion of the assets, just as the reader selling Afterpay did.

Harry Imber

Your site is Superb--always interesting,insightful and helpful. The diverse range of contributors is excellent. Thank you. Harry.

Robin Memory

I had always had a strategy of looking towards share income to support us in retirement and was a bit over exposed to higher dividend shares. The franking credit policy raised by labor, made me realize that there are many risks beyond the actual investments. My dependency on franking credits has been reduced, and to your first point, I now look towards capital growth as well and accept that selling assets is okay. Legislative risk is there as well for retirees and the constant changes around such areas as contribution limits adds to the pain. Thanks for Livewire, I get much value from it.

James Marlay

Hi folks, thanks for the feedback on Livewire and it is great to hear that the resource delivers some value for our readers. I also appreciate you sharing your own investing experiences - we're all different and can all learn as we go. Safe investing.

Paul Clarkson

At the same time this market has created the wealth bubble around property in particular. So many of these self funders are sitting on massive property capital gains. The next generation won't get this. Property can't go much further from here. We can't double down our current debt levels. It will force many to downsize, which is what they should do anyway to let the next generation have the larger homes rather than sitting on all those empty nests. So some empathy, but limited. I still think we will see the current retirees as the lucky generation that got to enjoy the period between the war and the consequences of overpopulation and environmental destruction.