March 17, 2016
Investing for Retirement Income: Straw, Sticks or Bricks? Part III
As we’ve discussed in the first two parts of this three-part series, we do not recommend turning to dividend-yielding stocks or high-yield (“junk”) bonds to buttress your retirement income, even in low-yield environments. So what do we recommend? Today we’ll answer that question by describing total-return investing.
Part III: Total-Return Investing for Solid Construction
If you think it through, there are three essential variables that determine the total return on nearly any given investment:
- Interest or dividends paid out or reinvested along the way
- The increase or decrease in underlying share value: how much you paid per share versus how much those shares are now worth
- The damage done by taxes and other expenses
Total-Return Investing, Defined
Instead of seeking to isolate and maximize interest or dividend income – i.e., only one of three possible sources for strengthening your retirement income – total-return investing looks for the best balance among all three, as they apply to your unique financial circumstances. Which strategy is expected to give you the highest total return for the amount of market risk you’re willing to bear? Which is expected to deliver the most bang for your buck, in whatever form it may come?
If you’re thinking this seems like nothing but common sense, you’re on the right track. Last we checked, money is money. In the end, who wouldn’t want to choose the outcome that is expected to yield the biggest pot given the necessary risks involved? Why would it matter whether that pot gets filled by dividends, interest, increased share value, or cost savings from tax-wise tactics?
In Total-return investing: An enduring solution for low yields,” Vanguard describes the strategy as follows: “Many investors focus on the yield or income generated from their investments as the foundation for what they have available to spend. … The challenge today, and going forward, is that yields for most investments are historically low. … We conclude that moving from an income or ‘yield’ focus to a total-return approach may be the better solution.”
And yet, many investors continue to favor generating retirement cash-flow in ways that put them at higher risk for overspending on taxes, chipping away at their net worth and weakening the longevity of their portfolio.
We’re not saying you should entirely avoid dividend-yielding stocks or modestly higher-yielding bonds. With total-return investing, these securities often still play an important role. But they do so in the appropriate context of your wider portfolio management. Let’s take a look at that next.
The Related Role of Portfolio Management
The tool for implementing total-return investing is portfolio-wide investment management. Decades of evidence-based inquiry informs us that there are three ways to manage your portfolio (the sum of your investment parts) to pursue higher expected returns; more stable preservation of existing assets; or, usually, a bit of both. The most powerful strategies in this pursuit include:
- Asset allocation – Tilting your investments toward or away from asset classes that are expected to deliver higher returns … but with higher risk to your wealth as the tradeoff
- Diversification – Managing for market risks by spreading your holdings across multiple asset classes in domestic and international markets alike
- Asset location – Minimizing taxes by placing tax-inefficient holdings in tax-favored accounts, and tax-efficient holdings in taxable accounts
By focusing on these key strategies as the horses that drive the proverbial cart, we can best manage a portfolio’s expected returns. This, in turn, helps us best position the portfolio to generate an efficient cash flow when the time comes.
Your Essential Take-Home
Bottom line, there is no such thing as a crystal ball that will guarantee financial success or a happily-ever-after retirement. But we believe that total-return investing offers the best odds for achieving your retirement-spending goals – more so than pursuing isolated tactics such as chasing dividends or high-yielding bonds without considering their portfolio-wide role.
With that in mind, the next time the market is huffing and puffing and threatening to blow your retirement down, we suggest you throw another log on the fire that fuels your total return investment strategy, shore up your solidly built portfolio, and depend on the structured strength to keep that wolf at bay. Better yet, be in touch with us to lend you a hand.