Building Efficient Income Portfolios

Traditionally, most portfolio optimization has focused on total-return analysis to the exclusion of income-oriented portfolios. Given the change in investor risk appetite as a result of the 2008 financial crisis, increased market volatility, demographic shifts, and the belief that growth rates will be lower going forward, the need and interest in income-focused portfolios is increasing.

Needing to use the income the portfolio generates while preserving the principal, investors who are at or near retirement are increasingly seeking income-generating portfolios and focusing on more predictable returns. Total-return portfolios may generate some income but may not be ideal for these investors. Yet there is only modest guidance available on how to build an efficient income-generating portfolio compared with the guidance available for total-return portfolios.

As the US population continues to age and people’s ability to accept risk (income volatility) diminishes, the demand for efficient income-oriented portfolios is becoming increasingly important. While total-return optimization is important, income-generating portfolios become more important as investors reach retirement. Read my entire CFA Digest abstract article here. - Paul R. Rossi, CFA