What is Total Return Investing and Why Is It Important?
April 13, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial
When comparing different investment options, one of the first questions most investors will ask is what is the expected return? When all else is equal—though this is rarely the case—rational investors will always choose the assets that can help them maximize their total return.
While most people realize that the “return” from an investment represents the money you receive for making it, some overlook the fact that returns can come in many different forms. If you buy a stock for $10 and eventual sell that stock for $20 five years later, this represents a $10 return. But if the stock also yielded dividends, as many stocks currently do, your returns may be even greater. If this particular stock offered $1 dividends every year, then over the course of 5 years your total return would be $15, rather than just $10. All of a sudden, the total ROI from the stock becomes 150 percent, rather than just 100 percent.
Clearly, investing in dividend-yielding stocks can be incredibly beneficial. However, what does this mean for the overall construction of your portfolio? Should you focus primarily on asset appreciation (hoping for the stock to go up)? Should you focus primarily on income streams (relying on dividends)? Or should you aim for something in between?
The income-appreciation trade off doesn’t just apply to investing in stocks, it applies to many other asset classes as well. Even the much more predictable bond market is driven by possible changes to the trading value of each bond, along with all pre-determined payments. Real estate investors, on a larger scale, look to not only invest in properties that will likely be worth more in the future, but also invest in properties that generate a reliable income stream (such as rents).
Total Return Investing
Both income-generating and appreciating assets have their share of pros and cons attached to them. Once again, we find ourselves wondering which makes the most sense for our portfolio. In many ways, this question creates a bit of a false dichotomy—rather than obsessing over theory or the structure of any particular asset, we believe there is a simpler way to construct a portfolio: choose whichever assets are most likely to produce the highest total return.
While this “total return” investing philosophy is remarkably simple, it also one that has proven itself to be exceptionally effective. While you will still need to recognize and be aware of your own risk preferences, which will ultimately affect which choices make sense for you, you can begin to effectively remove yourself from “needing” to invest in any specific asset.
The result, in most cases, will be a portfolio that consists of both income yielding and capital appreciating assets. This is not because either type of asset is necessarily superior or inferior to the other, but because positioning yourself this way can protect you from built-in risks (such as unexpected recessions), while also creating ample opportunities for your wealth to grow.
If you only rely on income or you only rely on appreciation, you will likely be creating an unnecessary level of risk that is not adequately compensated with matching returns. Narrowing, rather than broadening, your choices will be one of the surest ways to keep you from maximizing your total return. Maximizing your total return will very likely require some flexibility, especially if you are currently resistant to the idea of liquidating part of your holdings along the way. Still, if you can take a few steps back and look at the broader picture, it becomes clear that total return investing is simply the most logical approach.
Are you interested in investing in cryptocurrency? Read our article here.