Sometimes a successful financial future depends on doing things right, but it also depends on avoiding mistakes. These aren’t necessarily complicated or overly technical issues. Many times they’re pretty simple. One potential mistake is confusing income with cashflow.
Cashflow is how much money you need to support your living standard. Income is an accounting term which equals the interest and dividends your portfolio earns. Whether you look at income or cashflow has a huge impact on how successful your retirement will be. The most important number for your retirement success is “total return”. Total return includes “income” as well as “capital appreciation”.
The average stock portfolio will generate about 2% to 3% in “income”. But that same stock portfolio can be expected to earn an average “total return” of approximately 7% per yr. (even more if there’s inflation).
In normal years, if you compared the “income” generated by bonds (conservatively about 5%) with the “income” generated by stocks (2% – 3%), you’d be tempted to load up on bonds. Doing so, though, would deprive you of the 7% average “total return” of stocks.
To be successful and enjoy retirement fully, you need a properly diversified portfolio of both bonds and stocks in order to receive “income” and “capital appreciation”. Ultimately, your cashflow comes from this “total return”.