The crisis of 2008-2009 taught investors many important lessons, especially about the need for diversification, which can help manage a portfolio's overall risk. In particular, reinvested dividend income can help protect investors from downside risk and portfolio losses during declining markets. With many experts anticipating higher than average volatility, as well as single-digit returns for equities over the next decade, investors may want to take a closer look at multi-asset portfolios, which offer investors diversified, reinvested income.
To combat market volatility and potential market losses, consider total return that is comprised of both price appreciation and reinvested distributions. During market dislocation, while price returns may move into negative territory, that slide may be buffered by the positive effect of income. The chart shows the sheer power of reinvested dividends: over the past 40 years, price appreciation alone accounted for just over 26% of the total return of the S&P 500—the vast majority of the total return (more than 73%) was produced by reinvested income distributions. Once investors appreciate the benefit of reinvesting income distributions, it's important to understand there is a large universe of securities, beyond dividend paying stocks that provide the opportunity for price appreciation and reinvestment of income distributions.
Multi-asset solutions are one potential approach. These strategies offer exposure to a range of equity-type returns, from preferred and common stocks, to American Depository Receipts (ADR), to closed end funds—as well as REITs, limited partnerships, and a range of other income-generating assets. The goal is to improve performance by diversifying the portfolio's return stream as well as its risk profile. For example, MLPs have trounced the Morning¬star® US Market IndexSM over the past one-, five-, and 10-year periods. A $10,000 investment in MLPs made in 2000 is worth more than $97,000 today. That same $10,000 invested in the broad Morningstar US Market Index, meanwhile, is worth $14,976.
The chart shows that, in the multi-asset index, the share of income provided by different assets remains relatively stable over time. The table shows that these income streams have low correlation to each other, providing a potential diversification benefit not just for the component asset class returns, but also for the portfolio's income stream.
Finally, the quarterly rebalancing of multi-asset portfolios ensures a “buy low and sell high” management approach—similar to the idea of dollar cost averaging, in which the portfolio invests consistently through up and down markets, buying less of an asset when prices are higher and more when markets are lower.
Income-oriented investors should consider risk and income quality, in addition to just price appreciation. Multi-asset solutions may help diversify asset class risk, as well as the quality of the portfolio's income stream. And in today's economic environment that can be a critical consideration.
If market uncertainty continues, risk awareness is paramount, and in this environment, multi-asset solutions may offer income-oriented investors one of the most basic protections available: diversification.
William Belden is managing director of product development at Guggenheim Investments.