**Investing Explained: Why Total Return Investing Could Be Your Best Bet**
**Understanding the Basics:**
If you’ve been following the investment scene since 2008, you probably know about dividend investing. This is where investors put their money in stocks that have a strong track record of paying consistent dividends.
Another strategy to consider is total return investing. Here, the goal is to seek returns from different sources, not just dividends. This means looking at capital gains—which is the difference between the purchase and sale price of a stock—as equally valuable. The aim is to maximize returns for a certain level of risk, without focusing on where exactly those returns come from.
**Why Total Return Investing Makes Sense:**
Dividends are payments made to shareholders out of a company’s earnings, typically on a set schedule. Capital gains, on the other hand, are the profits you make when you sell a stock for more than you bought it. For example, if you buy a stock for $1 and sell it for $2, you’ve made a $1 gain.
When a company pays out a dividend, its stock value drops by that amount. So, a $10 stock paying a $1 dividend would then be worth $9. While you get instant income, your potential for future gains decreases.
John Bogle’s book, “The Little Book of Common Sense Investing,” shows that over the past 100 years, capital gains have contributed significantly to returns, and this trend has increased over the last 25 years. Dividends have declined from 4.5% per year to 3.4%, and today’s overall US stock market has a 2% dividend yield.
Capital gains account for at least half of stock market returns and recently, it’s closer to two-thirds. By focusing solely on dividends, you might be limiting your long-term growth potential, akin to favoring bonds over stocks, which traditionally offer lower returns.
**Diversification:**
Diversification is key in investing. It means spreading your investments across various assets to minimize risk. With a total return approach, you’re not restricted to dividend-paying stocks. You can invest in different types of companies, increasing your chances of growth since you’re not confined to a particular market segment.
**Risk Management:**
A common reason people go for dividend investing is that it seems to lower investment risk. Stable companies paying high dividends might seem less volatile. However, reducing risk this way ignores other investment opportunities. A well-rounded total return portfolio would include various assets like US Treasury bonds to manage risk without sacrificing returns.
**Tax Efficiency:**
If you are investing in tax-advantaged accounts, tax efficiency isn’t a big issue. But if you’re aiming for early financial freedom, you’ll likely use taxable accounts. Here, capital gains are more tax-friendly than dividends since dividends are taxed yearly. Capital gains taxes can be deferred, allowing you to reinvest and grow your money in the meantime.
**The Case of Dividend Aristocrats:**
Companies known as “dividend aristocrats” have raised their dividends for at least 25 years. Many claim these have outperformed the S&P 500, with less volatility. However, the returns from bonds have shown similar performance but with even lower volatility. Strong performance over recent years doesn’t guarantee a better long-term strategy. Like other companies, dividend aristocrats can still face challenges. For example, from 2009 to 2012, 27% of these companies changed.
**Implementing Total Return Investing:**
The simplest way to adopt a total return strategy is through total market index funds. These funds cover the entire US stock market, providing a wide range of risks and returns. The same approach can be applied to international markets, bonds, and real estate. Alternatively, if you prefer picking stocks, a total return strategy gives you the flexibility to choose from a broader range of stocks.
**The Bottom Line:**
Whether you’re investing for long-term growth or immediate income, the source of your returns—be it interest, dividends, or capital gains—shouldn’t matter. What’s important is achieving your financial goals with a reasonable level of risk. Total return investing offers diversification, tax efficiency, and the flexibility to utilize all market opportunities while managing risk effectively.
