In my time as a wealth advisor, I have heard numerous clients say some version of: “I want to live off my portfolio income in retirement and not have to touch the principal.” While the intent behind this line of thinking is positive and worthwhile, it leads people to construct a sub-optimal portfolio if their only goal is to generate income and dividends. Let’s talk about two different approaches to investing: income vs. total return.
The Limitations of Income-only Investing
Obviously, ongoing income in retirement is vital. However, since not all investments produce income, an income-oriented portfolio limits your options which in turn limits diversification. Touted as the only free lunch in investing, diversification is crucial for long-term success. Focusing your investments on only those that are income producing rules out investments that could increase your overall returns.
What Is Total Return Investing?
A portfolio that is designed to generate return through a combination of income and appreciation is known as a total return portfolio. There are a few key reasons why professional wealth advisors believe this to be the best investing plan.
With total return investing you have more control over portfolio taxes. Since you don’t have control over when companies or funds pay dividends and interest, you are subject to tax on that income whether you spend it or not. With an appreciated asset however, you only pay taxes on your gains when you sell it. Then it is taxed at the preferential capital gains rate versus interest income that is taxed at ordinary rates.
Second, total return investing provides more control over portfolio withdrawals. With an income approach, the market largely determines how much portfolio income you will have each year. With total return investing, since you have control over when you sell an investment, you can adjust your portfolio withdrawal rate easily if your spending habits change. It’s difficult to predict the future, at least in any real detail, so giving yourself additional options can be a lifesaver, especially in retirement.
Ultimately, the best portfolio strategy is the one that gives you the highest chance of achieving your personal goals. At Strategies Wealth Advisors, we find that tends to be a total return strategy. Contact us if you would like to talk more about your saving strategy or retirement goals.