As we’ve discussed in our last two posts, 4% should be a safe withdrawal rate for your retirement portfolio. The 4% Solution Getting More Mileage From Your Retirement Portfolio The best way to build a portfolio that will allow you to skim off 4% every year is to invest for total return. A total-return portfolio is built upon a foundation of equities and bonds that will generate dividends, interest income, and capital gains. With this strategy, a retiree will first tap into the income generated by bonds, stock dividends and any other income-producing investments. If that doesn’t generate enough cash, the retiree will sell off some appreciated shares of stock or other assets.
This investment strategy is called total return because it relies on the entire portfolio to generate cash for its owner. Academic literature overwhelmingly supports total-return investing and pension fund managers and other institutional investors have broadly embraced the practice. Investing for total return is a superior approach to the income-only strategy, which is what millions of retirees have depended upon for decades. As we’ll explore in our next post, when investors assemble a portfolio that depends exclusively on interest income, they end up chasing yield, which can get them into trouble.
A total return portfolio offers these significant advantages over an income-only one:
Let’s take a closer look at one way that a total-return devotee, who assembles a diversified portfolio, can benefit:
Despite all the prognosticating, no one can consistently and persistently predict what the markets will do in the future. For ]evidence, you can look at recent times. In the decade ending in 2009, for instance, stocks averaged annualized returns of negative 3% and lagged bonds by more than 9 percent. Bond lovers, however, are now in their fifth year of low interest rates. In 2007, 10-year Treasuries were yielding 5%, but recently they have dipped below 2%. In contrast, the Standard & Poor’s 500 Index is enjoying a three-year annualized return of 14.5%. One of the strong benefits of a diversified portfolio of bonds and stocks is that it is more likely to dampen volatility and enhance long-term returns when the markets are making investors’ stomachs queasy or just exasperating them. A diversified portfolio is less vulnerable to significant portfolio risks such as inflation and loss of purchasing power than one that’s crammed with bonds. Your best protection for achieving your portfolio goals against unpredictable financial markets is to invest for total return.