Investment Income – The Inconvenient Truth

One of the central pillars of our investment philosophy is that investment income is predictable and very different to investment growth. We know that the investment income from assets with volatile capital values (e.g. shares, property and higher yielding fixed interest stock) tends to be predictable and stable.

However, this fact appears to be somewhat inconvenient, particularly for those who work in compliance and design risk profiling systems, asset allocation models etc. It must be difficult to build an algorithm which takes account of the predictability of the income and the volatility of capital values. Rather than recognising that research which is based on total return only is flawed, particularly for those who are drawing an income from their investments, the risk profilers have ploughed on regardless and hope that nobody will notice. Compliance people seem a bit overawed by all of the complicated words used by the people who create these models. If they point out that the emperor is wearing no clothes, they might be the ones who have to design and make him a new set.

This has led to a gradual assumption that “total return” is the right approach to adopt for clients, whether or not they need an income.

It has been hard work to build an investment approach which incorporates the harvesting of the income, whilst considering capital volatility. I wonder how many other financial planners have also felt the need to invent the wheel as a result of the failure of the “experts” to come up with an acceptable solution?