Total Return vs. Dividends – Which Should Be your Focus?

By: Andrew J. Willms, President and CEO of The Milwaukee Company

In years past if all you wanted your investment portfolio to do was to provide you with sufficient cash flow to live on, you could invest in government bonds, collect the interest, and sleep soundly at night knowing your principal was safe and secure.

For example, in 1995 20-year treasuries yielded 7.97%, or almost $8,000 for every $100,000 invested. That meant $1MM invested in 20-year treasuries generated $80,000 in interest income a year. Not too shabby.

At the time of this writing, 20-year treasury notes are yielding just 1.37%, or $1,370 for every $100,000 invested. As a result, the annual yield generated on $1,000,000 invested today in 20-year treasuries is just $13,700. Not easy to make ends meet with that level of income.

It’s no wonder that individual and institutional investors alike are searching high and low for investments that generate more income. Dividend paying stocks, higher yielding, lower grade junk bonds, real estate investment trusts (REITs), and treasury-inflation protected securities (TIPS) have seen a surge in popularity as yields on bonds, CDs and money market funds have plummeted.

It’s not surprising that each of the alternatives mentioned has their drawbacks, as greater yields do not come for free. For example, dividend paying stocks provide less ballast when there is a bear market; junk bond prices are volatile and the issuer is more likely to default; REITs are cyclical by nature and can struggle when interest rates rise, and inflation will have to take hold for TIPs yields to become attractive.

Insurance agents are quick to suggest immediate annuities as the solution. An explanation of my concerns with that alternative is beyond the scope of this article, but you can find a concise discussion of them HERE.

In my view, investors who rely on their investment portfolio to pay the bills should pay less attention to dividend and interest rates, and instead look to their portfolio’s total return for their support. A portfolio’s total return is the sum of dividends plus interest plus price appreciation.

Taking a total-return approach to generate cash flow then, refers to using interest, dividends and capital gains as sources of income. In other words, a total return approach envisions the sale of securities included in the portfolio to the extent necessary to generate the desired level of cash flow.

Many of us were told from an early age that the key to successful investing is to “never touch the principal”. While that advice may have had some merit in years gone by, it does not make sense in today’s ultra-low interest rate environment.

To illustrate my point, let’s revisit our earlier example where we have $1,000,000 to invest, but this time let’s assume that we divide our $1,000,000 between bonds yielding 2% and stocks that generate a total return of 6%. In that case our total return will have increased from $20,000 to $40,000. And while its true that we will have to sell some of our stocks to realize the 6% return, both portfolios will be worth $1,000,000 at the end of the year.[1]

Of course, dividend and interest rates are more stable than the total return generated by stocks. You can’t get a free lunch on Wall Street. However, diversification and tactical risk management can go a long way to keeping the volatility of a total return portfolio to an acceptable level.

When properly executed, a total return approach targets the mix of assets that will generate the highest total return for your personal risk tolerance. In so doing, a well-designed total return portfolio can better meet your cash flow needs both now and in the future.


Recommended Reading:

  • Investing in a low interest rate environment: Should individual investors change their approach? Read More Here

Off our beat:

  • NASA captures images of a supernova that is five billion times brighter than our sun. Read More Here

[1] For the sake of brevity, I am ignoring the tax differences on how dividends, interest and capital gains are taxed. Suffice it to say that when properly implemented, the tax results of a total investment approach are competitive with an income only approach.

13 views0 comments

Recent Posts

See All