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By Christine Benz | 07-10-2014 02:00 PM

Generating Income in a Low-Yield World

Investors should avoid over-engineering an income-only portfolio and consider a total return approach to generating the income they need, says Vanguard's Fran Kinniry.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Retired investors face the challenge of trying to earn a livable income in a very low-yield environment. Joining me to discuss that topic is Fran Kinniry, a principal in Vanguard's Investment Strategy Group.

Fran, thank you so much for being here.

Fran Kinniry: Thank you, Christine.

Benz: Fran, one thing that we both see in our work is that investors do very much look for income from their investments. They want to be able to spend that yield and not have to invade their principal in any way. What are the risks of focusing strictly on current income when you are building your portfolio?

Kinniry: Right now, the taxable bond market has a yield of around 2%, and the dividends on stocks are around 1.8%. Normally the recommended spending is 3% or 4%. There is a gap.

So investors have tried to engineer a higher yield. They are overbuying dividend stocks--they'll buy stocks that have 3%-4% yield--or they'll go up the credit spectrum in fixed income toward corporates or high-yield corporates or emerging-market debt. The risk to that is, a) you're becoming less diversified, and b) you are concentrating your assets in a certain style and also your bonds now look closer to equities. So if we do run into any patch of trouble, you are going to be unlikely to be able to preserve your assets because all of your assets have some equity link to them.

Benz: Investors who are income-centric often hear, you should be total return-oriented. What does that mean in practice?

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