The Benefits of a Total Return Approach to Retirement Spending

By: Richard A. Anderson

Last year I wrote an article titled “The Shortcomings of Income Only Spending in Retirement,” which detailed the shortfalls of the popular strategy of spending only the income generated by a portfolio in retirement. In summary, the main drawback of income only spending is the tendency to increase portfolio risk when yields are low in order to generate more income. This is typically done in three ways: increasing allocation to long-term bonds, increasing allocation to lower quality bonds and/or increasing allocation to dividend stocks. These three strategies have the potential to increase investment risk, as well as decrease tax efficiency of a portfolio. So, if income only spending in retirement is not the answer, what is a better solution?

At HIGHLAND, we believe a total return approach, which considers both income and capital appreciation, is a more efficient approach to retirement spending than income only spending. Total return investing focuses on maximizing investment gains – dividends, interest and capital appreciation – to fund your retirement spending needs while assuming a level of risk commensurate with your risk profile. Dividends and interest remain prominent components of the total return approach, but when income is insufficient to support spending needs, the portfolio is rebalanced to convert capital appreciation to cash for consumption.

The point here is that the buying power is identical once the after-tax proceeds from your investments are converted to cash. It’s not just one type of investment gain you should be focusing on, but a combination of all three. If total return, rather than income, is maximized, the principal value of your portfolio is in a better position to increase in value. In this sense, the objective of this strategy is to maximize your long-term wealth while supporting your need for current income.


At HIGHLAND, we implement the total return approach through the use of a cash reserve strategy that sets aside years of spending in what we term a “distribution plan cash reserve.” The cash reserve is funded by required minimum distributions (if applicable), income and capital appreciation. The cash reserve allows retirees to spend down the cash in reserve during market declines, and then replenish the cash reserve by selling securities once the market has recovered. In our experience, clients can better withstand market declines when they know they have sufficient cash in reserve to support their short-term needs while waiting for the market to recover. In this sense, there is a behavioral and psychological benefit to a cash reserve strategy.

At the end of the day, an investor who is taking withdrawals from their portfolio has one goal: not to run out of money. In addition, investors want to feel secure and not have to worry where their next “paycheck” is coming from in retirement.  An income only approach is an inefficient strategy for achieving these goals because the income generated from a portfolio will fluctuate with interest rates. Therefore, investors commonly shift their asset allocation towards higher yielding assets, taking additional risk in the process.

Also, by holding bonds and dividend yielding stocks in taxable accounts, the investor is decreasing their tax efficiency because this income is taxed at ordinary income tax rates rather than long-term capital gains tax rates.

Essentially, by focusing solely on yield, investors trade higher current income for a greater risk to future income.

A total return approach, however, eliminates these inefficiencies as the desired spending amount doesn’t need to fluctuate with changes to interest rates, because assets are sold to meet spending needs. This is advantageous tax wise because capital gains are taxed at a lower rate than ordinary income. This strategy finds the perfect balance between the need for current income and future income.

In summary, an investment strategy that can achieve returns from all sources – interest, dividends and capital gains – can be better equipped to meet current spending needs while growing long-term wealth. This is especially important in an environment where interest rates and/or dividend yields are low. As such, adopting a total return approach to retirement spending allows you to capture income and capital appreciation to meet your spending needs throughout retirement. For more information on our approach to retirement spending, please contact a member of the HIGHLAND team.