A stark choice between capital growth and income ignores some very important points. First, inflation can substantially erode the purchasing power of capital, meaning that it is important that income seekers preserve the real (inflation-adjusted) value of their capital (unless of course they are happy to erode capital). Second, an investment can produce very different results, depending on how you use it, how long you hold it for and when you buy and sell it. You could, for example, purchase a growth-focused investment but potentially generate income from it in the future by encashing a proportion of the investment each year to generate income, and that income can potentially be tax efficient if it is within annual CGT exemptions.
Having said that I do accept that for many it is perceived wisdom that dividend paying stocks potentially reduce risk in a portfolio because, for example, with the use of accounting ‘tools’ such as amortisation and depreciation the ‘true’ state of a company may not be as clear as one might at first assume. But if a company is paying a dividend then that is cash that has to be generated. There is also the argument that high dividend companies tend, again as a generalisation, to be in more ‘mature’ industries and are therefore more defensive if markets were to suffer a setback.
I do accept that when considering an investment strategy certain investments are skewed to accentuate one or the other aspect of capital growth or income. It is important to remember however that the yardstick professional investors use when considering performance is generally total return, which includes both capital growth and income. Focusing solely on growth or income can produce, at best, a partial and at worst a misleading picture.
For me the most important initial consideration in portfolio construction is asset allocation or the process of determining optimal allocations for the broad categories of assets (such as equities, fixed interest, cash and property) that suit an individual’s investment time horizon and risk tolerance. We are all aware that studies have shown that this allocation may account for more than 80 per cent of the return of a portfolio. This is because each asset class will generally have different levels of return and risk. This leads to the concept of an ‘efficient portfolio’. An efficient portfolio is one which has the smallest attainable portfolio risk for a given level of expected return (or the largest expected return for a given level of risk). Optimal asset allocation is unlikely to be attained from one fund or from investing simply in growth or income producing assets.
