What is “Total Return Investing”?
Total return investing is an investment approach that aims to achieve higher returns that are generated not only from capital growth but from income as well. The sources of income may include dividends from equities, as well as interest received from fixed-income investments.
Total return strategies typically suit investors with a longer-term investment horizon. Unlike income investing, the focus here is not purely on generating higher yield, but rather to outperform by using a combination of share price appreciation plus income streams. Commonly, the total return can be also considered as the actual return on investment.
Key Learning Points
- Total return investing is an investment strategy that seeks to outperform a particular benchmark (or market index) by combining capital growth and distributed income
- Total returns can be from capital growth, interest, dividends, and other distributions
- While income investors focus on superior income yield that is distributed regularly, total return strategies do not focus on simply one outcome
- The total return is considered a strong method for measuring performance and is expressed as a percentage of the amount invested
- Growth strategies usually do not tend to include dividend-paying stocks, so price return alone would not be a fair calculation when comparing against total return or income funds
The Basics of Total Return
Total Return can be the best way of showing the actual return achieved on an investment. For example, if a portfolio has returned 10% over one year period, the driver for performance might not be just capital growth, but also dividend income and/or interest (or coupons) as well. Looking specifically at equities, some of the highest dividend-paying stocks are mature companies that do not offer the same growth prospects as their smaller peers. In this case estimating investment return on share price growth alone would not give the full picture of an overall return as it would not factor in the dividend income.
Company A has grown its share price by 10% over one year and has not paid dividends.
Company B has grown 6% over the same period, but also distributed dividends, so adding the 5% yield would make a total return of 11%.
Advantages of Total Return
There are various benefits of using a total return approach through a diversified portfolio. Income investing tends to be the preferred route for those investors who are in their retirement due to the regular payments. However, a total return strategy is most suitable for those looking for steady cash flow (e.g. to pay for living expenses) and to maximize the size of their portfolio over the long term.
It is worth noting that they are indifferent when it comes to the source of cash flow generation – this could be receiving dividends or selling assets. On the other hand, reinvesting dividends can also be a powerful mechanism for achieving a strong total return.
If there is a lower yield environment, it may force traditional income investors to seek higher yields, which may lead to changes in their original risk profile. Typically, this risk is likely to crystallize during periods of market turbulence and can sometimes lead to financial loss. In contrast, total return strategies could give investors a chance to meet personal objectives through withdrawals while still maintaining a diversified portfolio that meets the individual’s risk and returns requirements.