When it comes to investing, there are different approaches that investors can take. Two common approaches are total return investing and yield (or dividend) investing. While yield investing focuses on generating income from investments, the total return investment strategy focuses on maximizing overall returns, including income and capital gains. In this blog, we will explore the advantages of total return portfolio investing over yield investing.
First, let us define both approaches. Yield investing focuses on generating income through interest and dividends from a portfolio of income-producing investments, such as bonds and dividend-paying stocks. The goal is to generate a steady stream of income, often at a higher rate than what can be achieved through savings accounts or CDs. On the other hand, total return portfolio investing focuses on achieving both capital appreciation and income generation from a portfolio of diversified assets, including stocks, bonds, and other investments. Again, the goal is to maximize the total return, including income and capital gains, over the long term.
Advantage 1: Diversification
One of the critical advantages of total return portfolio investing is diversification. By investing in a mix of asset classes, investors can spread their risk across a range of investments and avoid overexposure to any one type of asset. This can help to reduce volatility and protect against downside risk. On the other hand, yield investing typically focuses on a smaller set of income-producing assets, such as bonds or dividend-paying stocks, which can leave investors more vulnerable to market fluctuations.
Advantage 2: Flexibility
Total return portfolio investing offers greater flexibility than yield/dividend investing. Investors have more options when selecting investments by focusing on overall returns rather than just income.
For example, if an investor is looking to generate only income from their portfolio, they may be limited to investing in bonds or dividend-paying stocks. However, with a total return portfolio, investors can also consider growth-oriented investments that focus on capital appreciation, such as equity and real estate investments, to name a few.
Income and yield-only investors face challenges because their universe of investable assets may only be bonds and dividend-paying stocks. Focusing solely on yield will likely lead to taking on more risk in a portfolio than otherwise desired. When a stock or bond is distressed, meaning its price is low relative to its peers, the security may look attractive from a yield perspective. Still, it likely means the security is riskier than other stocks or bonds in its industry or sector. Therefore, careful security analysis and selection, along with understanding risk management within the construct of a portfolio, is critical.
It is also essential to call out that by focusing on only dividend-paying stocks, an investor would be excluding 35-40% of firms from their investible universe (1). This choice directly affects the total portfolio’s level of diversification. Over the years, we have seen a global decline in the propensity of firms to pay stock dividends to shareholders. For instance, in 1927, 68% of US companies paid dividends, while only 38% of firms paid in 2021, as seen in the chart below (2) provided by our friends at Dimensional Fund Advisors.
Annual percentage of firms and market cap that paid dividends in the United States 1921 – 2021
While we cannot predict what the investing landscape will look like in the future, we can certainly lean on the historical data and trends within the investible dividend universe to make informed asset allocation decisions.
Advantage 3: Higher Total Return Potential
While yield investing can provide a steady income stream, it may not offer the same potential for long-term growth as total return portfolio investing. With a total return portfolio, investors can benefit from both income generation and capital appreciation. Over the long term, this can result in higher overall returns than what can be achieved through yield investing alone.
Advantage 4: Inflation Protection
Finally, total return portfolio investing can better protect against inflation than yield investing. With a mix of assets that includes equities, real estate, and other inflation-sensitive investments, investors can benefit from the potential for higher returns during periods of inflation. On the other hand, many income-producing assets, such as bonds, may not keep pace with inflation, eroding the purchasing power of the income generated.
In conclusion, while yield or dividend investing can provide a steady income stream, total return portfolio investing offers distinct advantages, including diversification, flexibility, higher total return potential, and better protection against inflation. Moreover, by building a portfolio designed to generate income and capital appreciation, investors can achieve their long-term investment and retirement goals more efficiently and successfully.
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Index
1. Data provided by Bloomberg. The countries are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the Netherlands, the United Kingdom, and the United States
2. Source: Fama/French US Portfolios Formed on Dividend Yield. See the Index Description for more information regarding the indices shown. Provided by Fama/French from CRSP and COMPUSTAT data. Includes all NYSE, AMEX, and NASDAQ stocks for which we have market equity for June of year t, and at least seven monthly returns (to compute the dividend yield) from July of t-1 to June of t. Portfolios are formed on D/P at the end of each June using NYSE breakpoints. The dividend yield used to form portfolios in June of year t is the total dividends paid from July of t-1 to June of t per dollar of equity in June of t.
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