What is “total-return investing” and how does it work?

In our recent blog post, STOP Chasing Dividends, we argued against employing the perennially popular strategy of targeting stock dividends to fund your retirement cash flow. We’re not saying you should avoid dividend-yielding stocks entirely, but total-return investing is our preferred approach to preparing for and managing retirement and other lifetime spending. With it, dividend-paying stocks can still play a role, but they do so in the more appropriate context of your larger, wealth management performance.

Total-Return Investing, Defined

Essentially, three variables determine the total return on an investment:

1. Interest or dividends paid out along the way
2. The increase or decrease in underlying share value – how much you paid per share versus how much those shares are now worth
3. The damage done by taxes and other expenses

Instead of seeking to maximize interest or dividend income in isolation, total-return investing looks at various investment strategies that balance all three of these concerns for each investor’s 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 – i.e., the most bang for your buck – in whatever form it may come?

Let’s Not Forget About Tax Efficient Investing …

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 for the risks involved? Why would it matter whether that pot gets filled with dividends, interest, increased share value, or tax efficient investing tactics?

And yet, many investors continue to favour generating 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. As I proposed in a MoneySense article, “The income illusion,” these tendencies are more a behavioural than a rational reaction. To help combat that, it’s also important to adopt a portfolio-wide perspective that incorporates a focus on tax efficient investing strategies.

The Related Role of Portfolio-Wide Management

Decades of evidence-based inquiry informs us that there are ways to manage your portfolio (the sum of your investment parts) to pursue: (1) higher expected returns, (2) more stable preservation of existing assets, or (3) a bit of both. The most powerful resources in this pursuit include:

1. Asset allocation – Tilting your investments toward or away from asset classes that are expected to deliver higher returns … but with higher risk to your existing wealth as the tradeoff.
2. Diversification – Managing for market risks by spreading your holdings across multiple asset classes in domestic and international markets alike.
3. Asset location – Minimizing taxes by placing tax-inefficient holdings in tax-favoured accounts, and tax-efficient investing 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.

We are not alone in our belief. In 2012, Vanguard published a helpful paper entitled, “Total return investing: An enduring solution for low yields.” If you are interested in a thorough analysis of the strategy, it’s an enduring piece, worth reading.

Bottom line: there is no such thing as a crystal ball that will guarantee investment success or a happily-ever-after retirement. But we believe that combining total-return investing with portfolio-wide management and tax efficient investing focus offers the best odds for achieving your retirement-spending goals – more so than pursuing isolated tactics such as chasing higher dividends or higher-yielding bonds.