Looking for more income? Seek total return and you may find

During my years as a wealth manager, I’ve learned that many clients have preconceived notions about investment strategies. One of the more common ones is that principal funds in a portfolio should never be tapped to improve cash flow for income needs. As such, they believe that only dividends and interest are available to them.

I strongly disagree with this belief. And to support my argument, I’ll draw on the popular conversation game and ask the following:

Would you rather:

Have a portfolio invested mostly or fully in bonds with an annual return of 5% to support your lifestyle?

or

Have a portfolio that appreciates by 15% with dividends and interest distributions accounting for only 1%?

I think most investors would actually prefer the latter. The bond portfolio, in addition to being self-defeating, would make portfolio management even more difficult as clients push to maximize distributions.

As a wealth manager, I manage for total return. As such, I inform clients about the importance of having a balanced portfolio focused on total return. A balanced portfolio that accounts for risk parameters can actually maximize an investor’s ability to support their lifestyle while maintaining future purchasing power.

What exactly does managing for total return mean? It means focusing on asset allocations — not on whether portfolio income gains are due to interest, dividends, or capital appreciation. If a portfolio is properly structured, in consideration of risk tolerance, it’s acceptable to generate cash flow not only from distributions, but also from the sale of portfolio gains from asset appreciation. The tax treatment of portfolio gains often validates this approach.

The strongest case for managing total return actually lies in modern portfolio theory. Portfolios built to maximize fixed-income distributions may very well be overconcentrated in asset classes that pursue yields while intensifying duration and credit risks. Assets and sub-asset classes — such as junk bonds, bank loans, emerging market debt, and leveraged alternatives — may be appropriate within a diversified portfolio, but never for the oversight of other mainstream, growth-oriented asset classes.

With a focus on total return, my approach is to construct an appropriately diversified portfolio, and then set statistical parameters to show its ability to augment a client’s lifestyle. If my analysis indicates the portfolio does not meet the client’s cash flow needs, my focus shifts to financial planning and setting spending limits versus searching for a new way to chase yield.

In my years in wealth management, I have also seen investors who experience what I call “financial neurosis,” a failure to adjust their spending habits even as their life circumstances change. While I cannot alter a client’s past financial decisions, I can work on maximizing total return today to ensure they have the cash flow to support their lifestyle in the future — even if it means accessing principal.

Working alongside a financial professional can help you navigate the future and reach your potential. To learn how our Private Wealth Advisors can help you, please call 1.877.670.5400, visit us online, or visit your nearest Citizens branch.