The Total Return Approach: Investing in a Low-Interest, Low-Dividend Yield Environment

When bonds and dividend yields can’t keep pace with inflation, how should investors plan for retirement? One idea is to take a total return approach.
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Key Takeaways

  • Low Treasury yields and hot inflation mean negative real rates
  • Rethink your attitude toward income

  • Consider creating a virtual dividend with growth stocks

The past few years haven’t been easy on income investors. Now, with inflation picking up, it could get worse before it gets better.

As of late June 2021, the yield on 10-year U.S. Treasuries was hovering around 1.5%, and the dividend yield on the S&P 500 isn’t much richer. And with inflation scorching at more than 5%, inflation-adjusted real yields—the consumer price index minus the 10-year Treasury yield—are negative. That means inflation is chewing up the purchasing power of those low-yielding investments.

Even if inflation ends up being a temporary phenomenon (or “transitory” as the Federal Reserve has suggested), income investors should consider reframing their thinking. Rather than looking at income traditionally as yield from debt instruments or even dividend payments, think about “total return” price and yield as you design your portfolio around the income you’ll need in retirement.

Plus, although the Fed might see inflation as abating soon, others see it quite differently. Either way, a total return approach to investing might help you toward your goals. 

Two Sources of Return for Stocks

“It’s important when we think about any investment to think about the sources of return,” explained Viraj Desai, senior portfolio manager at TD Ameritrade Investment Management, LLC.

Here’s the breakdown: If you bought XYZ stock at $100 and the price increases to $110, you’ve made a 10% price return on the stock. If XYZ stock also pays a $2 dividend, you’ve made a total return of 12%.

Growth stocks are more likely to see total return from price appreciation, while value stocks are usually expected to generate both dividend and price appreciation as part of their total return.

People who invest in dividend-paying stocks may start to worry if the dividend yield falls when the stock’s price rises, such as during a recovery period.

“That can be alarming for some, particularly if you’re creating a portfolio to maximize yields,” Desai said. “All of a sudden, all these yields are coming down. But they don’t have to bump up the income payment because the price is appreciating.”

Bonds: Prices and Coupons

With bonds, there’s both a price return and an income return, too. In bonds, the yield is very important, but Desai explained that just focusing on the yield is “purely an accounting consideration.” Investors need to think about the economic value behind it, too, especially for investors who don’t own individual bonds but buy bond mutual funds and exchange-traded funds (ETFs).

Suppose you own a bond paying a 2% coupon and interest rates rise to 3%. The value of your bond would be lower relative to the prevailing market environment. Nothing’s changed with your bond—it still pays a 2% coupon and, at maturity, you’ll get your principal back (unless the issuer defaults, of course).

With bond mutual funds and ETFs, the net asset value is calculated daily based on current interest rates, and even though the income stream may not materially change daily, the price of that vehicle fluctuates due to the forces of supply and demand, according to Desai.

What does it mean if the yield starts to rise suddenly? It doesn’t mean the debt holder is suddenly wealthier or that there’s more income in the portfolio. Rather, the price return of those assets has declined so much that yields have been propped up. “It’s really important to know that,” Desai cautioned.

Another Way to Think About Dividends and Income

Given the fluctuation in income assets, what can the income-seeker do, especially in this environment? The answer goes back to the idea of total return, and in this case, systematically liquidating a portion of positions in non- or low-dividend paying instruments.

Many growth-oriented stocks don’t pay dividends, and in the current market environment, many companies that plow earnings back into the firm have continued to see share price appreciation—think big tech heavyweights like Amazon (AMZN) and Google parent Alphabet (GOOG). Here’s a way to make that growth stock perform like a value stock—from a total return standpoint.

Suppose you need a portfolio with a 2% dividend but you’re not getting that in coupon payments. Look at your stocks that pay no dividend. Take 2% of that portfolio and have it pay out (to yourself) each year.

“All of a sudden you’ve given yourself a 2% dividend,” Desai remarked.

For investors who’ve been trained to never sell growth stocks to allow those holdings to benefit from compound growth, it’s time to (partially) reconsider this assumption, especially in the current market cycle for people who are in the decumulation phase of their portfolio and need income.

In today’s market environment, growth stocks continue to rise sharply, and those gains may cover the small percentage you might sell to meet income needs.

The poster child of this example is MacKenzie Scott, the ex-wife of Jeff Bezos, Amazon’s founder. She’s pledged to give away all her wealth, and has donated $8 billion since her announcement last year. Yet because of the price appreciation of Amazon’s stock, her total wealth has increased, even as she has systematically sold off some of her stock.

That’s the lesson income investors can learn—not to be afraid to sell off small portions of growth stocks to fund income needs in the current environment.

“What she’s doing is she’s basically creating a virtual dividend because Amazon doesn’t pay dividends. She’s taking the cash from the price appreciation to fund her charitable donations,” Desai noted.

Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. The risk of loss in trading stocks can be substantial.

Investing in bonds has principal risks associated with changes in interest rates and the risk of default, when an issuer will be unable to make income or principal payments. Bonds and bond funds will typically decrease in value as interest rates rise.

Debbie Carlson is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.


Key Takeaways

  • Low Treasury yields and hot inflation mean negative real rates
  • Rethink your attitude toward income

  • Consider creating a virtual dividend with growth stocks

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