Ken Fisher Explains Investment Income vs. Cash Flow

A material mistake that people make, pretty commonly, is to think about the format in which returns come to you in cash from your investments and confuse that with the format of the investments themselves. And by that, what I mean is that you commonly hear people say things like, "well, I'll spend my income, but I don't want to dip into my principal. I get this much from my interest and this much from my dividend yield, and that's what I can spend. I really can't spend more than that. I'd be dipping into principal." You hear that pretty commonly. You may have said that yourself.

Now, in reality, the only thing that really should matter to you and the way you should think about it is not that. But instead, what is your long-term total return reasonably expected to be, regardless of the format of how that total return is generated to you? Does that total return come from price appreciation, dividends, interest income adjusted for tax?

The fact is, it's the total return that defines what your long-term well-being will or will not be. And that total return is what your target investment goal has to be aimed at. Once you think that through relatively conservatively, with a margin of error in case you're wrong. Income that you need really doesn't matter whether you get it from interest, dividend yields or taking some of your appreciated principal. The fact is, once you set a reasonable cash-need level, you can generate your cash flow simply by doing what I call creating homemade dividends, which is harvesting just enough of your capital appreciation over time to cover that which you need, which is a reasonable percentage of your total and doesn't eat in too much to your long-term total return.

In doing so, you can plan for what your long-term assets will accumulate into. You can be relatively tax efficient, and you can avoid the mistake of trying to say to yourself, "if I get big dividend yield or big interest income, I can spend it." Because in fact, if the interest income or the dividend yield is big and you spend it, but your total return is small, then your future is smaller than it would be, and you really do need to save more. But if your total return is abundant relative to what you need in cash flow that you create out of the homemade dividends, then your long-term future is good. And that's really what you should aim at, making your long-term future good.