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Rising Interest Rates : Creating Growth-powered Income

Conventional financial advice often draws a distinction between growth and income portfolios. This article argues that a portfolio of growth stocks can be a good strategy to generate income, especially in times of rising interest rates. 

Investors often buy bonds and annuities in retirement to achieve capital preservation and income generation. Over the past ten years, due to record low interest rates, bonds have provided no meaningful income. During this time, many income seeking investors moved up the risk curve buying high dividend stocks, which were seen as a bond-replacement. 

An alternative to relying on dividends as the only source of income, a growth strategy can provide income through regular stock liquidation. The key benefits of this strategy are; flexibility, financial performance, and potential tax advantages. 

Starting with taxes: Cash flows derived from selling stocks are taxed differently, and depending on the jurisdiction, often more lightly than dividend income. 

Second, flexibility: A growth-powered income strategy offers investors the flexibility to decide whether to accumulate capital or steadily sell stocks to provide income. Unlike dividend flows, cash-flows generated by selling can be timed according to the investor’s need. 

And third, financial performance: As a test of whether a growth strategy can generate sufficient regular income, we compare a dividend strategy versus a growth strategy over the past five years. The dividend strategy is represented by the Global X SuperDividend US ETF (DIV). Each month, the ETF pays a dividend of 0.55%, which accumulates to an income of 6.5% p.a. The growth strategy is represented by the iShares S&P 500 Growth ETF (IVW). Each month, enough shares are sold to match the dollar amount distributed by the dividend ETF. Over the past five years, the drawdown on capital is more than offset by the superior growth of this portfolio. While the price performance of the dividend ETF is roughly flat over the past five years, the growth strategy enjoys a capital gain of 58% over the five-year period in addition to the 6.5% p.a. dividend income. 

What about risk? The growth strategy is more volatile than the dividend strategy with volatility of 13% and 10% respectively. Reducing exposure to the higher-risk strategy so that a 10% volatility is achieved, the investment still outperforms in terms of value generation while matching income of the dividend strategy.   

In terms of concentration-risk, dividend portfolios are often concentrated in a few sectors, like financials, oil and gas, or utilities. Sector concentration exposes the portfolio to single risk factors like; financial crises, a falling oil price, or in the case of utilities, rising interest rates.  

A digital wealth management platform can implement a growth-powered income strategy. It offers the functionality to sell stocks regularly to provide income while matching a portfolio to an individual’s risk profile. Quantifeed’s platform offers investors the flexibility to reinvest or de-invest according to their investment needs and income requirements. 

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