The Fear of Relying on Yield for Income

In the second part of our series on retirees’ need for income, we’ll look at the fear or hesitancy of investors and financial advisors to construct an income portfolio based on yield for income. With more than four million Baby Boomers and Gen Xers reaching retirement age each year between now and 2030, it is critical to address the question on investors’ minds–how do I generate income from my investments to afford my retirement lifestyle?

As we addressed in our previous post, Real Income: Using Dividends and Interest to Avoid Running Out of Retirement Funds, there are numerous methods of generating income from your investments. However, we believe that the most effective and efficient method is using dividends from stocks and interest from bonds.

Even though generating income from dividends and interest may be the most efficient method, most people in the wealth management industry are not comfortable constructing portfolios based entirely on the yields of stocks and bonds. 

In a recent Morningstar webinar, titled “Strategies for Boosting Retirement Spending: How Advisors Can Maximize Client Outcomes (Safely)”, the hosts acknowledged this dilemma. In the Q&A exchange, a question was raised: “How is income generated in a portfolio in your research?”

The response was, “We’re focusing on a total return approach, so income plus capital appreciation. But the income alone, is it going to be enough to kind of make up for that withdrawal rate? So we are going to pull from the portfolio to make up for whatever the income doesn’t deliver… So, we are depleting the portfolio.”

In other words, if an investor or client needs $40,000 per year of income from their $1 million portfolio, as an example, they would design the portfolio to generate 2% in yield from the stock and bond positions and liquidate 2% of the portfolio with the hope that the portfolio appreciates 2% or more each year.

Relying on the portfolio to appr

eciate 2% each year subjects it to the sequence of returns risk, which is a major risk for retirees who rely on income from their portfolios. 

Sequence of Returns Risk

When relying on the portfolio to appreciate each year, it matters when the market is up and when it is down. If the market, as represented by the S&P 500, were to produce positive returns in the first several years of retirement, this would significantly increase the likelihood that the portfolio would last beyond one’s life expectancy. 

However, if the market were to enter into a downturn the first few years into retirement, the likelihood of running out of money in the later years of retirement increases substantially. In other words, it matters if you happen to retire during a bull market or a bear market.

Capital Appreciation vs. Yield

One of the reasons financial advisors are not constructing income portfolios based on yield is the fallacy that if you depend on yield entirely for income, then the portfolio will not grow or will be devoid of capital appreciation.

It is important to understand that there is an inverse correlation between capital appreciation and yield. In general, the more potential for capital appreciation of an investment, the lower the yield is of that investment. This can be seen in the characteristics of growth stocks where they generally have lower dividend yields or none at all because growth companies are able to generate more return per dollar from reinvesting earnings than distributing them to shareholders in the form of a dividend. Conversely, dividend paying stocks tend to have a lower earnings growth rate than growth stocks, which is eventually reflected in the lower historical capital appreciation of its stock.

As a result, when constructing a portfolio using dividends for income, it is important to understand the relationship between capital appreciation and yield. Doing so, enables you to still generate sufficient income from yield and factor in future capital appreciation from your investment positions, particularly from stocks.

When it comes to bonds, the coupon or interest payment is the main attraction. Rarely would an investor generate significant capital appreciation returns from bonds unless they were distressed or rated below investment grade.

Sample Income Portfolio

Below is a sample income portfolio (Table 1) that generates 4% in income entirely from its yield. This would meet a situation where a retiree needs $40,000 per year from their $1 million portfolio. In this example, the table below shows the annual income each investment position would generate based on their respective yields. 

Sample Income Portfolio

Table 1

Fund	Asset Class	Percent of Portfolio	Investment Amount	Yield	Annual Income
Dodge & Cox Stock Fund	U.S. Large Cap	15%	$150,000	1.27%	$1,905
Franklin Income Fund	Dividend Equity Income	25%	$250,000	5.01%	$12,525
Capital Income Builder	Global Equity Income	20%	$200,000	2.47%	$4,940
Loomis Sayles Bond Fund	Long Bond Fund	20%	$200,000	4.42%	$8,840
American High Income Trust	High Yield Bond	20%	$200,000	6.27%	$12,540
	TOTAL	100%	$1,000,000	4.08%	$40,750

Source: Morningstar

Using a mix of mutual funds from multiple fund families as an example, the portfolio is allocated with 60% equities (stocks) and 40% bonds. Based on each fund's yield, the average yield of the portfolio is 4.08% generating approximately $40,750 in annual income from a $1 million portfolio. By designing a portfolio based on asset allocation and yield of each fund, it is possible to generate the desired annual income needed by the retiree.

Naturally, one can design a portfolio to maximize the income beyond the need of an investor, but this is where the relationship between capital appreciation and yield must be taken into account. The more yield the portfolio generates, the less potential capital appreciation or growth. So, it is critical to find the right balance between growth and yield in designing portfolios for retirees.

In fact, constructing an income portfolio based on yield is a fairly simple task. The real art and science lies in the rebalancing and reallocation of the positions of the portfolio as interest rates and prices change over time. Maintaining the overall current yield or target income of the portfolio while continuing to position it for growth over the long term is the ultimate objective.

Appreciation Above Yield

To address the fear of relying on yield for income, you have to look at a stock’s historical price appreciation above its yield. This can be seen in the long term return of a stock beyond its dividend yield. 

For example, according to Claude AI, Johnson & Johnson (JNJ), which has paid a rising dividend over the last 60 years, has returned an average of 9% the last 20 years. During that same time period, JNJ’s average dividend yield was 2.84%. From this example, we can extrapolate that the average capital appreciation above yield is approximately 6.16%.

For mutual funds and ETFs, you can identify the same future capital appreciation potential using their historical average annual returns minus their yield.

Using the same funds from the income portfolio above, we can see the appreciation above yield for each fund:

Appreciation Above Yield

Table 2

Fund	Percent of Portfolio	10-Year Annual Return	Yield	Appreciation Above Yield
Dodge & Cox Stock Fund	15%	13.26%	1.27%	11.99%
Franklin Income Fund	25%	7.10%	5.01%	2.09%
Capital Income Builder	20%	8.08%	2.47%	5.61%
Loomis Sayles Bond Fund	20%	4.06%	4.42%	-0.36%
American High Income Trust	20%	6.57%	6.27%	0.30%
Total	100%	7.51%	4.08%	3.41%

*Returns and Yields are as of March 10, 2026.  Source: Morningstar

In Table 2 above, based on each fund’s percentage allocation and their 10-year annual return, the portfolio shows a historical 3.41% capital appreciation above its yield. This indicates that the portfolio could grow an additional 3.41% over the long term after distributing 4.1% in income each year. Of course, past results are no guarantee of future results, but it does show that the portfolio as constructed retains its potential for long term growth. 

In addition, since the allocation of the portfolio is not even across the five holdings or positions, some positions will grow more than others just as some positions generate more income than others. In fact, one position, Loomis Sayles Bond Fund, shows a negative appreciation above yield, indicating that it will likely not contribute to growth in the portfolio over the long term. This is where continuous rebalancing and reallocation is important, just like any other portfolio–growth or income.

The purpose of identifying appreciation above yield is to be able to generate sufficient yield that an investor needs while still positioning the portfolio for growth in the long term. This approach eliminates the need to liquidate shares each year for income, reducing the reliance on capital appreciation and subjecting the portfolio to the sequence of returns risk.

By using this appreciation above yield metric, financial advisors can have more confidence in designing portfolios that rely on 100% of the income being generated from yield. Instead of being fearful that they are sacrificing future growth, advisors can focus on the priority of income for their retiree clients.

Conclusion

By designing income portfolios based on yield and selecting quality holdings that have a track record of capital appreciation beyond their yields, investors and financial advisors can achieve both investment objectives of consistent and reliable income and long term capital appreciation. 

This method of income generation is more reliable and predictable than the commonly used 4% rule where investors withdraw 4% of their portfolio balance each year without knowing where the income will be coming from. Thus, relying on capital appreciation alone has its risks and is unpredictable.

Using dividends and interest for income, investors can sleep well at night knowing how much income they can expect to receive and where it’s coming from. Financial advisors can be reassured that they are not sacrificing capital appreciation, knowing that the portfolios are still designed for growth.