Many of our clients, particularly our retirees, look to their portfolios for a portion of their spending needs. Indeed, one of our core financial planning strengths is cash and liquidity management—generating cash for those monthly or quarterly distributions. Our clients view these distributions as their retirement “paycheck.”
So it’s natural that clients might think our strategies focused on income—bond interest and stock dividends—and simply sending that income along.
But there’s a problem with an income-only strategy. Even with bond yields today north of 4%, focusing just on yields ignores the strong growth that stocks bring over time.
Are there ways of increasing those bond yields? Sure, but not without taking on additional risk. And riskier bonds often act like stocks, going down sharply when the markets get rough. You lose the benefit of diversification by adding risk to your bond portfolios. That’s why we stick with a high-quality, “sleep-well-at-night” bond strategy.
What about adding in stock dividends? Yields on broadly diversified portfolios are pretty low. The dividend yield on the S&P 500 is only about 1.5%.
A total-return approach to investing—generating cash from both portfolio income and selling a portion of stocks as they appreciate— is more effective than looking at income alone.
Our total-return approach starts with understanding an investor’s goals. We create a targeted mix of cash, bonds, and stocks that is tailored to each client’s need for ongoing distributions, their time horizon, and their ability to live with the inevitable ups and downs of the markets.
As the markets move, we look to rebalance portfolios by bringing them back to their targeted mix. That’s an important part of a total-return strategy. Let’s say a client’s target is 50% stocks, and thanks to strong stock market performance their actual stock percentage becomes significantly higher. Selling some stock not only brings them back closer to that 50% target (reducing risk), it also creates cash, which is available for those regular distributions.
What about capital gains taxes? When we do take gains in a taxable account, we try to be as tax-efficient as possible. We remind clients that capital gains tax rates are often lower than rates on ordinary income.
The benefit of our total-return approach? Clients have peace of mind knowing they can count on their monthly retirement “paycheck.” We’ll handle the details, using the very effective total-return approach.
David Rappaport, CFP®