Schwab Intelligent Portfolios | April 1, 2021

Investment strategies and how to generate cash flow while staying invested

Investing Insights

Key Points

  • Schwab Intelligent Portfolios® offers three diversified investment strategies: Global, U.S.-focused, and Income-focused.

  • The investment strategies differ in their underlying investments, but all can be used whether you are saving toward a goal or withdrawing money.

  • Schwab Intelligent Income® is a feature that can be utilized with Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium® Global and Income-focused accounts to facilitate tax-smart withdrawals to meet cash flow needs.

Schwab Intelligent Portfolios offers you a choice among three investment strategies: Global, U.S. Focused and Income Focused. Each strategy provides access to a well-diversified portfolio of stocks, bonds and cash based on your investment goal, time horizon and comfort level with risk. And, each strategy can be a suitable way to achieve your financial goals, whether you are early in your career, saving for retirement or ready to enjoy your time in the sun.

Schwab Intelligent Portfolios Investment Strategies
Global Our flagship portfolios, designed to offer broad and well-diversified exposure to domestic, international and emerging market economies
U.S. Focused For those investors who prefer more familiar U.S.-domiciled investments that contain less exposure to international economies and no exposure to emerging market economies
Income Focused Designed for clients who prefer underlying investments that make higher and more stable interest and dividend payments

How does an Income-focused strategy differ from other investment strategies in Schwab Intelligent Portfolios?

In most situations, when you purchase an investment or security, your money can grow in two ways: (1) periodic payments in the form of either dividends (from stocks) or interest (from bonds) and (2) a change in value when you sell the security. The former is typically referred to as "yield" and, together, both are called "total return." If it helps, think of owning a rental property – you might receive monthly rental income (yield) from leasing the property to a tenant and, when you go to sell the property, its market value may have increased since the time that you bought it (price return).

Academic theory tells us that a stock's price reflects all the expected future cash flows to shareholders. Therefore, there is a counterbalance between yield and price return: if cash is paid today in the form of a dividend, you might expect the market price of the stock to fall. Schwab Intelligent Portfolios believes it's less important to focus on the yield of your investments and more important to focus on an investment’s total return.

All else equal, we understand why some investors may have a preference for more predictable sources of return, like dividend and interest payments.1 The Income-focused strategies include allocations to underlying securities or companies that pay out a higher percentage of their earnings or total return in the form of interest or dividends. But the Global strategies make interest and dividend payments, too. The Figure 1 chart below is a hypothetical example of what the differences between the Global and Income-focused strategies could look like. Both strategies have a total return of 6%, but the composition between yield and price return are different, with a higher percentage of the Income-focused strategy's total return coming from yield and a lower percentage of the total return coming from an expected increase in value.

Figure 1: Price return vs. yield in Global and Income-focused investment strategies

Figure 1: Price return vs. yield in Global and Income-focused investment strategies

For illustrative purposes only. Not representative of any particular account.

The difference between Global and Income-focused strategies can also be illustrated by the portfolios' holdings. The table below shows the top five holdings underlying the U.S Large Cap allocation for Schwab Intelligent Portfolios Global and Income-focused strategies.2 The Income-focused strategies invest more in so-called "blue chip" companies that tend to pay larger dividends, where a traditional market index like the S&P 500 (which is used to construct the U.S. Large Cap allocation included in our Global strategies) may be overweight allocations in "growth" oriented stocks (those that typically pay out less of their earnings to shareholders and therefore have a larger market capitalization).

Top 5 large cap holdings in Schwab Intelligent Portfolios strategies

Source: Schwabfunds.com3  as of 12/31/2020

Taking withdrawals to generate cash flow from an investment strategy

If you are nearing or in retirement, you are likely most concerned with the "income" (cash flow) that can be drawn from your portfolio. You might also think that if you need cash flow, you should be invested in an Income-focused strategy. This isn't 100% correct. In fact, any of our investment strategies may be appropriate for someone in retirement. And, depending on your financial situation and preferences, the Income-focused strategy may be appropriate even if you aren't yet in retirement.

Here, it's important to distinguish between an investment strategy, and the cash flow that can be generated from an investment strategy. While dividend and interest payments are one source of cash flow, it can be generated several ways – the most obvious and easiest being from cash reserves held in the account. Proceeds from the sale of securities is another very common way to generate cash flow from retirement savings and can be advantageous from a tax perspective.4

The process to generate cash flow when you need it can be difficult and tedious, especially if your desire is to keep your savings invested and working for you while you are withdrawing (and it should be). The first question to ask yourself is: How much do you need and how much can your savings and investments support? Then it's a question of how and from where? Which accounts and which positions or securities? Drawing down cash will not only deplete your cash reserve but will make your remaining portfolio more aggressive.

Decisions about whether to reinvest interest or dividend payments and which securities or positions to sell have both investment and tax implications. It’s easy to get overwhelmed. Schwab Intelligent Income was designed to help and to automate these decisions for you – providing tax-smart withdrawals (across any number of enrolled Schwab Intelligent Portfolios accounts) to support "income" (cash flow) needs while keeping your portfolio well-diversified and invested according to your risk profile.5 Many may be accustomed to what we would call a "dividends and interest only" method of generating cash flow. For most, dividend and interest payments are unlikely to cover income needs on their own. Schwab Intelligent Income is more than just dividends and interest payments and will sell securities and rebalance your investments, as needed, to keep you on track to meet your retirement goals. 

Conclusion

Schwab Intelligent Portfolios offers investment strategies that can be tailored to your goals, risk tolerance, time horizon, and investment preferences. While there are some notable differences between the underlying holdings of the strategies and source and the composition of your investment return, each provides similar risk and return characteristics and has the horsepower to help achieve your goals. And, when the time comes to turn those investments into a recurring stream of cash flow, Schwab Intelligent Income is here to help.

Eric Tarkin, Managing Director with Charles Schwab Investment Advisory, Inc.