The Importance of Total Return

In yesterday’s post I asserted that when it comes to assessing the role of stocks and bonds in your retirement investing, total return is of paramount importance. Conversely, and more accurately stated, the distinction between yield and appreciation is of no real importance. It’s a red herring.

As pointed out in February 27’s post, for some purposes, yield is considered “income” and appreciation is considered “principal,” and for those limited purposes, the distinction between income and principal matters. But not for retirement planning.

But “wait,” you say, “when I start my retirement spending years, shouldn’t I spend income and preserve principal?” “No,” I respond. Utilizing that somewhat arbitrary distinction can cause you to distort your all-important asset allocation plan, to invest too much in bonds (in an effort to boost yield, i.e., income), or too much in stocks (in an effort to preserve the purchasing power of your assets). If your goal is to preserve the pot (and I’m not suggesting that should be your goal), then it’s much more rational to focus on total return and how that affects the percentage of your assets you can sustainably spend.

But “wait,” you say, “then might I not have to sell some assets to generate living expenses?” “Yes,” I respond, but so what? When you buy food, your grocer wants cash. She doesn’t care whether it came from yield or the sale of a share of stock. And cash can come from either income or principal.

But “wait,” you say, “won’t I incur costs in selling assets?” “Yes,” I respond, but commission costs are low and stocks are very liquid, making those costs immaterial compared to the cost of distorting your asset allocation plan.

But “wait,” you say, “what about triggering capital gain taxes?” “Duh,” I respond. First of all, a lot of your assets will be inside the shelter of your tax-favored retirement accounts, where realizing capital gains has no tax impact. And if some of the assets to be sold are in a taxable account, realizing capital gains taxes is actually much cheaper than paying tax on interest and dividend yields of a like amount. With capital gains, you only pay taxes on the appreciation portion of the amount you realize on sale, rather than on every dollar as is the case with interest and dividends. And usually at a bargain rate, too!

But “wait,” you say, “what if the stock has gone down in value? I’ll never get those dollars back.” “So what.” I respond. The act of selling a hammered stock makes you no poorer than if you keep it. It just makes the depreciation weigh more on your mind. The money was lost when the stock went down, not when you sold it.

So except for old-fashioned trusts, which few of us have, the distinction between yield and appreciation matters not a bit. What does matter—a lot—is the relative volatility and uncertainty of yields and appreciation (or depreciation). And that’s for another day.