Income or growth? This question has been asked and answered repeatedly over time with varying answers depending on one’s agenda and/or one’s own situation. My answer is that it depends, the answer to all good questions. In this article, I will endeavour to explain why it depends.
First and foremost, income and growth are simply just two different ways that an investor gets rewarded for going out into the market for taking on some form of risk. In many circumstances, the greater the risk, the greater the potential for return.
Growth is a strange concept; it is almost imaginary until it is realised. It is kind of like a lady sitting at a poker table watching her stack of chips growing as she wins hand after hand. If she walks away from the table with chips in hand, she gets to keep her winnings. Just like if an investor sells an asset for more than they bought it, they have experience capital growth.
However, if she goes all-in and loses it all, all the initial growth in her chip stack is meaningless. The same as when an investor holds on to a stock that was up 30%, that then falls by 50%. Up until you take that risk of the table, growth is not yours.
It is for this very reason that growth is the riskier of the two ways one can be rewarded for accepting risk. The ATO even prices this in for us by giving capital gains tax (CGT) discounts for investments held longer that 12 months.
Income is far less ambiguous; it is cash in your hand. Once you receive income, it cannot be taken away unless you spend it. If you want to “grow” your portfolio, you can just reinvest it.
By focusing more of your return on income, you reduce volatility and downgrade your exposure to sequencing risk.
Which one is better?
I personally hate the term ‘better’; it implies that things are linear and that there are only two versions of the truth. In fact, there can be many and it generally all depends on context. When deciding to skew your return focus in favour of growth or income, it is critical to look at your tax environment.
In your personal name, the 50% CGT discount can be worth hundreds of thousands of dollars depending on the size of the investment and the time in the market. This is a material difference and could very well be worth the additional risk.
In a superannuation fund in accumulation phase, the reduction of the tax rate from 15% to 10% is somewhat less attractive. Although, the point needs to be raised that a direct investment held and sold in pension phase can result in that gain being taxed at zero anyway. It all depends on the timing of your exit strategy.
When a superannuation fund enters pension phase, the discount is gone (assuming we are under the transfer balance cap) and with it, the justification for chasing growth. Now I am not saying that investors should ignore growth entirely, but it seems illogical to me to focus on the riskier type of reward when there is zero benefit.
In a world of high marginal taxes rates and long investment time frames, growth deserves the focus. The lower the tax rate, absolutely in nil tax rate environments, income is king.
It is hard for a superannuation manager, who builds his/her fund for members of all ages, to account for this but it absolutely is smart portfolio construction for investors to keep in mind.