At Marriott Asset Management, our whole focus of investing is to generate an income. Based on our extensive research into optimising an income stream, we have established that the best way for an investor to achieve an adequate level of income and to grow his or her assets is to invest in those assets which demonstrate growth in income. This means that fixed income assets, such as cash, are less desirable than equity and property.
In addition, the extent to which investors draw down capital to sustain an income level or a particular lifestyle, will impact significantly on future income levels as well as capital growth and capital preservation. The more income one draws and spends now, the less is available to create future income. When inflation is added to this quandary, it becomes important to grow that income over time, so as to retain one’s buying power.
Capital preservation is ultimately dependent on two variables: the performance of the underlying assets (capital and income returns); and the extent to which income is drawn from the annuity. Through maintaining exposure to the two asset classes which provide the best hedge against inflation – equities and property – investors will be in the best position to keep income levels increasing. These assets need to be blended to achieve an optimal asset allocation within a balanced portfolio, whilst considering risk.
An advantage of property and equity investments is their growth in income streams. In the case of property, if its income wasn’t able to grow, its income nature would be very similar to bonds. There is, however, additional risk associated with acquiring and retaining tenants, as well as general business risks (since the properties are housed in a company structure), so property investments need to yield more to compensate for this additional risk.
Equities are also able to grow income over time and the value of a company rises at the rate at which its profit grows. In the same way, the value of an investment grows over time at the rate at which its income grows. Therefore investments that grow their income will increase the value of a portfolio over time.
By combining high yielding investments (ie, bonds) with investments that have the ability to grow their income (ie, equities), it is possible for an investor to attain a reasonable level of income with inflation-hedged income and capital growth. The income can be used to fund a lifestyle or can be reinvested to accumulate more capital.
Constructing a portfolio for future income involves determining an investor’s risk tolerance and recognising that investment risk lies with income growth. Unlike income yield, which is known at the time of investment, income growth is less predictable. Therefore, capital accumulation by re-investing income is a more certain and predictable way of increasing the size of an investment. Over the longer term, however, capital value growth resulting from income growth will generally produce a greater increase in investment value.
Although capital growth receives a great deal of investor attention, investing is ultimately all about income. Marriott has three pieces of advice for investors:
The best route to achieve success is to focus on income and let the capital take care of itself,
Capital drawdowns should be avoided as far as possible, to preserve the level of capital and to provide for income in future periods, and
Reinvest as much income as possible to ensure capital accumulation.