This week's response comes from:

Lou Stanasolovich

Louis P. Stanasolovich, CFP is Founder, CEO, and President of Legend Financial Advisors, Inc. (Legend), a fee-only financial advisory firm with its headquarters located in Pittsburgh, Pennsylvania.  Legend provides Wealth Advisory Services, including Comprehensive Financial Planning and Investment Management, to affluent and wealthy individuals as well as business entities.  Mr. Stanasolovich has been selected by Worth Magazine as one of “The 250 Best Financial Advisors in America” five successive times, by Medical Economics as one of “The 150 Best Financial Advisors in America for Doctors” three consecutive times and most recently by Mutual Funds magazine as one of “The 100 Great Financial Planners in America” in its October, 2001 issue.  His investment process has been profiled in Barron’s, Business Week, Investment Advisor, Investment News, Morningstar Investor, USA Today, Worth, and on the Internet publication TheStreet.com.  He can be reached via e-mail at legend@legend-financial.com, via the website - www.legend-financial.com, or at (888) 236-5960.

What does "growth and income" mean?

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What does "growth and income" mean?

from Stephen

Q: What exactly does "growth and Income" mean? We need to structure a portfolio with about one-third to one-half devoted to income production to supplement Social Security and private pensions being received monthly, and wondered whether it's appropriate to use "growth and income" in conjunction with fixed income to make up that income-producing portion.

We would be using the income from the investments, as well as the principal, to supplement, leaving the other half or so of the portfolio to grow over the next ten years.

A: (Lou) Growth and Income typically refers to mutual funds that own mostly equities and a small amount of bonds and/or money market instruments that generate a small amount of income for the shareholder. This is usually in the one to two percent these days.

I would strongly suggest that you rethink your desire to build a portfolio to generate income. This is an outmoded manner of thinking. What is important instead is determining what percentage of the asset pool needs to be withdrawn each year.

For example, if the portfolio is geared to earn a gross return of 11% (all equities) over the long term (fifteen plus years) then a 5% withdrawal rate is possible. If the portfolio is geared to earn a 6% gross return (60% equities, 40% fixed income) then a 2% withdrawal rate is possible.

Portfolio construction is critical as well. For example, you can design a portfolio with significantly lower risk than the market yet be almost all equities, which can provide equity-like returns by utilizing unique combinations of funds that are truly diversified. A portfolio of this type would look something like the following:

Bank Loan Fund - 16.7%
Domestic Equity Fund(s) - 16.7%
REIT Mutual Fund - 16.7%
Long/Short Mutual Fund - 16.7%
Announced Merger & Acquisition Arbitrage Fund - 16.7%
Tactical Asset Allocation Fund - 16.7%

As you can see, all six of the above categories are equally-weighted. They are also rebalanced annually.

This type of portfolio will provide approximately only a third of the volatility of the market, which is ideal for taking withdrawals from a portfolio. Distributions are paid into a money market fund at a discount brokerage firm (all funds are held there to facilitate trading, withdrawals, as well as distributions from mutual funds). Therefore, monies can be set aside for income distributions during the year and excess money market funds can be utilized for rebalancing purposes.

Important Disclaimer

Investing in equities involves a serious principal risk, and no assurance can be given that the techniques described here will be successful. Returns vary and you may have a gain or loss when you sell your shares. Past performance is no guarantee of future results. Index returns shown are historical and include the change in share price, reinvestment of dividends, and capital gains. Indexes are unmanaged and do not reflect the impact of transaction costs. Transaction costs would have reduced the total returns.

International investments, especially those in emerging markets, entail greater risks (as well as greater potential rewards) than U.S. investing. These risks include political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less-established markets and economies.

Lastly, the questions and responses set forth here are for general informational purposes only and are not intended to substitute for performing your own independent research or contacting your financial or legal professional before making any investment decisions. We make no guarantees as to the performance of any investment strategy you choose and are not responsible for any losses you might incur.