Total Return Investing - A Superior Solution To Generating Reliable Distributions
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Transcript of Total Return Investing - A Superior Solution To Generating Reliable Distributions
8/6/2019 Total Return Investing - A Superior Solution To Generating Reliable Distributions
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TOTAL R ETURN INVESTING: A
SUPERIOR SOLUTION TO GENERATING
R ELIABLE DISTRIBUTIONS
By: Frank Armstrong, CFP, AIF
www.investorsolutions.com 800-580-8500
Your grandfather invested for income and crammed his portfolio full of dividend stocks, preferred
shares, convertible bonds, and more generic bonds. The mantra was to live off the income and never
invade principle. They selected individual securities based on their big fat juicy yield. It sounds like a
reasonable strategy, but all they got was a portfolio with lower returns and higher risk than necessary.
At the time, nobody knew better so we can forgive them. They did the best they could under the
prevailing knowledge. Dividends and interest were much higher for your grandfather than they are
today. So, while far from perfect, it worked after a fashion.
Today, there is a far better way to think about investing. The entire thrust of modern financial theory is
to change the focus from individual security selection to asset allocation and portfolio construction, and
concentrate on total return rather than income. If the portfolio needs to make distributions for any
reason such as to support lifestyle during retirement we can pick and choose between the asset classes
to shave off shares as appropriate.
The Synthetic Dividend
Recognizing that distributions are funded opportunistically from any portion of the portfolio without
regard to accounting income, dividends, or interest, gains or losses we might characterize the
distributions as a “synthetic dividend”.
Total return investing abandons the artificial definitions of income and principle which led to numerous
accounting and investment dilemmas. It produces portfolio solutions that are far more optimal than the
old income generation protocol.
The total return investment approach is universally accepted by academic literature and institutional
best practices. It’s required by the Uniform Prudent Investment Act (UPIA), the Employee Retirement
Income Security Act (ERISA), common law and regulations. The various laws and regulations have all
changed over time to incorporate modern financial theory, including the idea that investing for income
is the inappropriate investment policy.
Still, there are always those that don’t get the word. Far too many individual investors, especially
retirees or those that need regular distributions to support their lifestyle, are still mired in grandfather’s
investment policy. Given a choice between an investment with a 4% dividend and a 2% expected growth
or an 8% expected return but no dividend, many would opt for the dividend investment, and they might
argue against all the available evidence that their portfolio is “safer”. It is demonstrably not so.
8/6/2019 Total Return Investing - A Superior Solution To Generating Reliable Distributions
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Unfortunately, in our present low interest rate environment the demand for income producing products
is high. Fund companies and managers are rushing to bring income solutions to market in an effort to
maximize their own returns. Dividend strategies are the darlings of salesman, ever ready to “push them
the way they are tilting”. And, the press is full of articles on how to replace lost interest income in a zero
yield world. None of this serves investors well.
So, how might an investor generate a stream of withdrawals to support his lifestyle needs from a total
return portfolio?
An example
Start by selecting a sustainable withdrawal rate. Most observers believe that a rate of 4% is sustainable
and allows a portfolio to grow over time.
Make a top level asset allocation of 40% to short term, high quality bonds the balance to a diversified
global equity portfolio of perhaps 10 to 12 asset classes.
Cash for distributions can be generated dynamically as the situation requires. In a down market, the 40%
allocation to bonds could support distributions for ten years before any volatile (equity) assets would
need to be liquidated. In a good period when equity assets have appreciated, distributions can be made
by shaving off shares, and then using any surplus to re-balance back to the 40%/60% bond/equity
model.
Rebalancing within the equity classes will incrementally enhance performance over the long term by
enforcing a discipline of selling high and buying low as performance between the various classes varies.
Some risk averse investors may chose not to rebalance between stocks and bonds during down equity
markets if they prefer to maintain their safe assets intact. While this protects future distributions in theevent of a protracted down equity market, it comes at the price of opportunity costs. However, we
recognize that sleeping well is a legitimate concern. Investors will have to determine their preferences
for re-balancing between safe and risky assets as part of their investment policy.
Conclusion
A total return investment policy will achieve higher returns with lower risk than a less optimum dividend
or income policy. This translates into higher distribution potential and increased terminal values while
reducing the probability of the fund self liquidating. Investors have a lot to gain by embracing the total
return investment policy.