When thinking about income from an investment portfolio many people focus on interest and dividend income. That can lead to problems. In times like these where interest rates are low, the desire to get income from bonds and high dividend paying stocks can be hazardous.
Bonds that pay high yields may be low grade “junk” bonds that are riskier than high grade bonds. Or they can be long-term bonds that will lose value when interest rates rise.
Stocks with unusually high dividends may actually be paying more in dividends that they earn. How long can that go on? Focus too much on dividend income and you could be like those who, in 2008, owned lots of bank stocks that were paying some of the highest dividends. Some of these banks failed and shareholders lost all their money. The survivors cut their dividends to – or near –zero.
Don’t misunderstand; getting income from bonds and stocks is not bad. But “reaching” to get income from these sources can be hazardous.
There is another way of getting income from an investment portfolio that does not focus on just interest or dividends. It’s called the “Total Return” system.
Total Return introduces a third factor into the income mix: growth.
Let’s use a stock as an example.
Imaging that we buy XYZ company stock at $100. It pays a dividend of $3. That gives us a dividend yield of 3%. But let’s assume we chose XYZ stock not just because of the dividend but because we believed it would grow. A year later, XYZ stock is now selling for $110. The “Total Return” on XYZ is the sum of the dividend and the growth in value.
Dividend: $3.00 (3%)
Growth in value : $10.00 (10%)
Total Return: $13.00 (13%)
Under these circumstances, we could take the dividend plus part of the increased value of the stock, spend it, and still have more wealth than we had before. Viewed from the Total Return principle, we could spend up to $13 and be wealthier than before.
This example is easier to accomplish using mutual funds, and it’s one of the strategies that we employ for those who are retired and those who are still building their retirement portfolio.
If you want to know more about the Total Return way of investing, contact us.