Is "Total Return" Part of Your Comprehensive Financial Plan?

By Jeremy Sorci | December 16, 2016

When you're considering your comprehensive financial plan, are you taking total return into account? If you're not looking at total return, you're not alone; many retirees are still attempting to live off the interest from fixed-income investments.

Jeremy Sorci is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt CountyUnfortunately, that's not always a feasible plan, given today's low interest rates. Once upon a time, retirees could live off of the interest from bond investments; however, a 10-year Treasury note currently yields just over 2 percent. That means if you invest $10,000 in a 10-year note, you'll get about $210 each year, after taxes and inflation, before getting your initial investment back at the end of a decade. 

Given these low rates of return, it's no surprise that many retirees are stuck with a difficult choice: turning to investments that expose their portfolios to more risk or making do with less income. If neither of these options sounds very desirable, consider strategic financial planning based on total return. Here's how it works.

Financial Planning and Total Return: The Basics

What is total return? It's a way to measure the performance of an investment -- or a pool of investments -- across two categories: Income and growth. Income may include:

  • Dividends
  • Distributions
  • Interest

Growth, also known as capital appreciation, is the change in an asset's market price, for instance, when stocks go up in value. Total return takes both of these indicators into account, and offers a more holistic way of evaluating your portfolio's performance.

So how can an investor structure her portfolio to maximize total return? By separating investment assets into the two categories of "income" and "growth."

An Investment Management Solution: Focus on Income

As any experienced investor knows, the market will have ups and downs. In order to deal with this volatility, you can set up regular payments through assets that produce income. Not only will you have a predictable income stream, you'll lower your overall exposure to risk.

Income producing investments may include: 

  • Stocks that pay dividends
  • High-yield bonds
  • Real estate investment trusts

Remember, though, that you're focusing on total return, rather than just income. Say, for instance, that you've got a stock that's paying a 10 percent dividend. However, the stock's value has actually decreased by 8 percent. Taking total return into account, this stock is only really paying 2 percent -- not even keeping up with inflation.

Asset Management Solutions: Focus on Growth

According to the U.S. Department of Labor, the average American spends about 20 years in retirement. Assuming a 2.4 percent average rate of inflation, the same item you purchased for $100 at the start of those two decades would cost $161 at the end. Investing some of your assets with a longer time horizon and with a more risk exposure -- i.e., investing into equities -- offers the potential for a longer-lasting portfolio. 

For example, let's look at the S&P 500 index over its history, from 1871 to 2013. The annualized return is just over 9 percent. Now say you invested about 30 percent of your portfolio into an index fund, receiving about 2.72 percent return. Though that return isn't much more than that offered by Treasury bonds, you've still got the rest of your portfolio to invest in other allocations.




Posted in Retirement Planning