Do you want to grow your capital, increase your income or both? Your answer will determine the type of investments you select and, in addition, you need to be aware of the concept of ‘total return’. This is the measurement of performance – the actual rate of return of an investment or a pool of investments over a given evaluation period. Total return includes interest, capital gains, dividends and distributions realised over a given period of time.
Income and capital appreciation
Total return accounts for two categories of return: income and capital appreciation. Income includes interest paid by fixed-income investments, distributions or dividends. Capital appreciation represents the change in the market price of an asset. Total return looks to combine income with capital growth to achieve the best overall return.
Whether you choose an income or a growth fund will typically depend on your circumstances and objectives – in other words, your investment time frame, your attitude towards investment risk and what you need the investment to provide for you.
A regular stream of income
If you need a regular stream of income, focusing your portfolio on assets that will help you achieve this, such as cash and bonds, will provide a fixed income. If you have a longer investment time period or you do not need an immediate income, you could consider a larger allocation to growth-focused investments.
It is possible to buy an income fund and a growth fund to capitalise on the advantages that come with each type of investment strategy. Some investment houses manage both income and growth funds, which provide a little of each style in the same fund; however, there is usually less choice available.
Whatever your preference, if you hold a variety of investments, both growth and income, you should be better prepared for future economic ups and downs. As your financial situation changes over time, you may need to make the necessary adjustments to your investment portfolio and switch from growth assets to income.
Investment timeline
Broadly speaking, younger people are saving for the long term and don’t necessarily need their investments to produce a current income but will be looking to guard against inflation. Under these circumstances growth funds may be more appropriate.
For middle-aged investors, growth funds are still generally the right option, but the amount invested is likely to be larger as a result of higher income and savings accumulated over previous years. With a secure capital base behind them, middle-aged investors may also consider putting part of their savings into some higher risk investments, such as more specialised pooled funds.
When investors start to approach retirement, their priorities change. Having built up a capital sum, they usually need to start switching towards funds that provide an income once they stop work. Although share-based investment funds tend to do well over the long term, they can swing sharply in value over the short term. So people of retirement age should perhaps consider switching into more defensive, income funds at this point.
