Your portfolio can help you accomplish many goals, and in retirement, a significant one is producing a steady income stream. After all, you’ve diligently saved and invested for years to ensure it can serve that critical function.
Solely relying on portfolio yield was a popular and somewhat reliable strategy a couple of decades ago. However, in this low-interest-rate environment, we continue to be in over the last decade, is relying on yield alone the most dependable strategy to meet your spending needs in retirement?
Given the low yields of traditional income-producing assets, like bonds and dividend-paying stocks over the last decade and even more, pronounced throughout the COVID-19 Pandemic, it’s prudent for investors to consider an alternative approach: total return investing.
What is a total return strategy? How does it differ from traditional yield-based approaches? Let’s find out.
What Is Total Return Investing?
Total return investing travels beyond the portfolio’s yield to include capital gains, dividends, interest, and realized distributions; it nods to the future and views the portfolio holistically, opening up an array of income opportunities.
This approach is different from the traditional fixed-income (or bond) strategy because it considers the entire picture instead of one detail. In addition, by expanding beyond immediate cash (interest and dividends) parameters, you have more flexibility to build and maintain the portfolio long-term.
The total return approach focuses on each investment’s role within the portfolio to create an effective and synergistic combination to support your long-term needs.
Essentially, with total return investing, the whole is more than the sum of its parts. In addition, the combination of the asset location, time horizon, risk capacity and tolerance, and your unique goals add depth and purpose.
When it comes to yield, it’s easy for investors to have blinders on because yield is a tangible way to track cash. However, a yield-first strategy tends to be less effective because it lacks diversification and increases an investor’s risk.
A few high-yield asset examples include Emerging Market Bonds, REITs, and High-Dividend Paying Stocks. What makes these securities riskier?
- Emerging Market Bonds expose investors to risk due to the less-developed political systems and currency fluctuations.
- REITs (real estate investment trusts) represent a narrow economic sector, and too much could lead to more risk.
- High-Dividend Paying Stocks run the risk of keeping investors over-concentrated in only a few market sectors.
3 Ways A Total Return Approach Can Be More Comprehensive
Your financial needs in retirement are diverse, so your investment approach should be comprehensive enough to help you meet those needs. Let’s take a look at a few ways a total return approach can elevate your portfolio.
Focus On Diversification
Shifting the focus solely from yield to a total return portfolio structure increases the number of available asset classes and diversification opportunities and ultimately reduces your portfolio’s overall risk.
Specifically, you can focus on creating a holistic and diversified portfolio. Doing so allows for much more resilience during different market environments. Given a traditional 30-year retirement horizon, your portfolio will experience several economic, interest rate, and market cycles.
Maintaining a long-term strategic diversification based on your goals and tolerance for risk allows you to take a comprehensive approach to manage your portfolio and investment goals. Then, when you create a plan for the big picture, you can focus on increasing the opportunity for “total” portfolio returns—critical to fulfilling your income needs.
It’s essential to consider the role taxes play in your investment decisions. While you shouldn’t let the “tax tail wag the dog,” remaining mindful of your overall tax situation can likely extend the life of your portfolio. Gross investment portfolio performance is important, but what you keep after taxes is more important.
For instance, by focusing on fixed-income and dividend investing, you may find yourself with more taxable income than necessary—for investments taxed at ordinary income rates no less.
With a total return approach, you may be able to leverage realizing long-term capital gains to generate income, currently taxed at more favorable long-term capital gains rates.
Additionally, a total return approach allows for increased tax efficiency through tactical asset location. Asset location focuses on placing income or yield-producing holdings in tax-advantaged accounts and more growth-oriented holdings in taxable accounts to prioritize after-tax returns.
Holistic Withdrawal Plan
Building a holistic withdrawal plan comes down to your unique income needs.
Understanding your income streams and planned expenses can help you determine how reliant you’ll need to be on your portfolio over the long term. Investing in a globally diversified portfolio by definition means your portfolio will produce capital gains, fixed-income interest, and dividends and allow you the ability to build a reliable annual withdrawal according to your retirement planning goals.
Your retirement plan isn’t set in stone. Odds are things will change as you move through retirement, and your spending needs may change along with it. Accounting for this change may involve a simple rebalance or potentially a complete re-assessment of your risk profile. By viewing your investments from a total return perspective, you can be more flexible when plans change.
Coordinate Your Portfolio With Other Retirement Income Streams
You will have other sources of income outside of your investment portfolio, which are instrumental in covering your living expenses. Consider the following.
- Try to set a precise “retirement date.” It’s always good to know when your employment checks will stop and your retirement benefits will start.
- Consider all of your guaranteed income: Social Security, annuity, pension, rental property, etc.
- Create a plan to make up the difference.
When you take a comprehensive look at your retirement income streams, you’ll better understand the role your portfolio needs to play in creating a total return to fulfill your annual lifestyle spending needs and long-term goals.
Know Your Retirement Spending Needs
As you begin contemplating the next phase of your life, it may be challenging to conceptualize how you’ll fund your retirement. However, it’s essential to start sketching ideas early on so you’ll have a better sense of your actual spending needs by painting the picture, even if it’s a little fuzzy early on.
- Will you have paid off your mortgage before retirement? Are you planning to downsize or purchase another house, or both?
- Will you be supporting any children or other family members?
- If you retire early, have you thought about healthcare expenses before Medicare kicks in at age 65?
- Are there other more significant spending goals like a vacation or home renovations on the horizon?
Build A Plan With Your Needs In Mind
In retirement, building a customized long-term plan and tailored investment strategy to meet your lifestyle go hand-in-hand to give you the best opportunity to achieve your goals.
A total return investment approach opens up new opportunities for your portfolio. For example, instead of fixating on yield, you can look at how the portfolio functions as one unit and create a strategy to optimize it.
At Columbus Street Financial Planning, we want to understand your goals and values and help you make well-informed investment decisions to put you on the path to retirement success. So schedule a call with us today.