Total Return Investing
Investors can give many different answers to the question of why they put their money at risk in the capital markets, but it can be boiled down to just two: We invest to either grow our capital so that we may spend (or gift) it in the future or to produce current income to help support our lifestyle. These two goals have historically suggested two different investment strategies: investing for long-term growth (stocks) or investing for income (bonds). In this month’s blog, we will discuss a third approach, total return investing. Before doing so, let’s take a closer look at investing for income.
The late 1970s and early 1980s may have been the best time in U.S. history for income investors. For example, in September of 1981, you could have purchased a thirty-year U.S. Treasury Bond that would earn 15.2% per year every year without fail until maturity in 2011, free of any default or credit risk. Imagine receiving an income stream of $1,520 every year for every $10,000 invested, for thirty years, unconditionally guaranteed by the U.S. Government.
Those were the days, you might be thinking. Who needed equities? But before we wax too nostalgic, let’s put this into some context. As some of you may remember, inflation was a very serious problem back then, rising to double-digits in the late 1970s, peaking at over 14% by April of 1980. Then, Paul Volker, a “hawk” on inflation, was appointed in 1979 as the new Federal Reserve Chairman. He eventually implemented an aggressive approach to fighting inflation by tightening the money supply and allowing overnight Fed Funds to reach almost 20%, which also drove up all other interest rates. Because many sectors of our economy then were reliant on borrowing, high interest rates threw the country into two back-to-back recessions in 1980 and 1981, and unemployment rose from 6.3% to 10.8%.
Despite great political pressure to lower interest rates, the Fed stayed the course, and by October of 1982, inflation had fallen to 5%. Today, Paul Volker is widely credited with “breaking the back” of long-term inflation. This, in turn, began the great Bull Market in Bonds, with bond yields steadily falling for the next 36 years, as bond investors grew more convinced that inflation was finally under control (bond prices move inversely to changes in interest rates).
Income investors face a very different situation today. Inflation remains very low, and so do interest rates. A 30-year Treasury Bond purchased today earns a yield-to-maturity of 1.43%, which would produce an income stream of just $143 per year for every $10,000 invested. The Federal Reserve has recently signaled that interest rates are likely to stay low for quite some time, even if inflation begins to increase. In fact, Fed Chairman Jerome Powell said during a press conference on June 10, 2020: “We’re not thinking of raising rates. We’re not even thinking about, thinking about raising rates.”
Low interest rates leave income investors with very few, if any, relatively safe alternative sources of higher income. This causes some investors to look for higher yields in riskier investments, such as high yield bonds, preferred stocks, bank loans, MLPs and REITs. While these investments may have their place in a well-diversified portfolio, the reason they generally pay out higher income than treasuries and high-grade corporates or municipal bonds is that they also carry more equity-like risk and volatility.
This brings us back to total return investing. “Total return” simply refers to the two components of investment returns, income and capital gains, in contrast to focusing on income alone. Investors using this approach fund their income needs from their overall asset allocation, by selling appreciated assets (most likely equities) to raise funds needed from time-to-time to fund lifestyle expenses. In a low rate environment, this approach shifts the emphasis away from finding higher yielding (but riskier) assets. Total return investing may also be potentially more efficient from a tax perspective, given that long-term capital gains are currently taxed at a lower rate than taxable interest and dividends.
Total return investing is an important element of the investment process at Coyle Financial, but it doesn’t happen in a vacuum. Your overall portfolio asset allocation is a carefully designed component of your unique financial plan, which considers your cash flow needs, tax situation and your tolerance and capacity for risk, among other things. Further, your whole financial picture is reviewed periodically with your advisor to make sure it is up-to-date.
To summarize: Total return investing is one important element of your financial plan that helps you to reach your long-term financial goals.
John serves as Chief Investment Officer for Coyle Financial Counsel and is responsible for overseeing the investment process. John’s prior experience includes managing institutional fixed-income portfolios for corporations, pension funds, non-profit organizations and foundations at several large, global asset managers. With more than 20 years of institutional investment experience, he is energized by helping individuals understand the role investing plays in meeting their long-term financial goals.
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All information is from sources deemed reliable, but no warranty is made to its accuracy or completeness. This material is being provided for informational or educational purposes only, and does not take into account the investment objectives or financial situation of any client or prospective client. The information is not intended as investment advice, and is not a recommendation to buy, sell, or invest in any particular investment or market segment. Those seeking information regarding their particular investment needs should contact a financial professional. Coyle, our employees, or our clients, may or may not be invested in any individual securities or market segments discussed in this material. The opinions expressed were current as of the date of posting, but are subject to change without notice due to market, political, or economic conditions.
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