Just as there are numerous investors in the markets, there are numerous styles of investing. And when proponents of a certain style meet die-hard fans of another, sparks usually fly and the two duke it out over who is correct. Buy and hold vs. sector rotation, index vs. active management, etc. All pale in comparison to one particularly bloody battle. No fight is as big and perhaps as violent as the skirmish between total return investors and dividend growth investors (DGI).
Seriously, check out the various investor message boards dealing with the subject. They can get pretty heated.
Both styles are actually perfectly valid and can yield the same result for a portfolio — namely, generating income near or in retirement. The question is which is better for you, and does one or the other give you a slight edge?
The Showdown
The fight between DGI and total return comes down to a few fundamental differences between the two styles. Cue Michael Buffer.
In this corner, wearing the white trunks, we have dividend growth investing. The style is loosely defined as buying dividend-paying stocks and investing those dividends into more shares. Over time, your share count increases to the point where a modest starting investment is now throwing off some serious livable dividend payments every year. Investors using DGI never sell shares in their dividend stocks or worry about what those shares are worth. They buy the income stream that the shares throw off.
Wearing blue stripes is total return investing. Using a combination of capital appreciation and dividends, investors using total return try to maximize accumulation of portfolio value. Needed income is generated by selling off fund or stock shares.
Each has their strong points and various weaknesses. But after going ten rounds, total return investing wins by majority decision.
The Reasons for Total Return’s “Win”
Truth be told, there’s nothing wrong with straight dividend growth income investing. But total return does have a slight edge: flexibility.
The real goal of using a total return strategy is to consistently grow your retirement nest egg even after you’ve begun to withdraw money. Investors doing this use a diversified basket of investments, including everything from bonds, cash and even dividend stocks. The flexibility comes in just how you begin to withdraw the funds needed in retirement. Market down this year? Lean more heavily on the bond side and the dividends. Stocks are rallying? Equities can provide the punch.
And while DGI investors will argue that they can just sit back and collect the checks no matter the market, consider this: what if you get sick? Not dire, but sick enough, and after a hospital stay you’re now forced to sell off some shares to pay the bills. Under a DGI growth model in retirement, you’ve now taken a huge cut to your “paycheck.” As for total return, the flexibility and ability for growth allows you to potentially bounce back better from such a scenario.
Then there’s actual dividend growth to consider. The question becomes: can a stock continue to grow its dividends at a high enough rate to cover rises in food, energy and other living costs? Maybe not. Investors relying on DGI models in retirement may not be able to “live” at the same standards if their paychecks don’t rise fast enough. Again, a total return investor would be able to navigate this scenario better.
Finally, total returns could be better from a tax point of view. Most investors have a multitude of accounts when they retire — 401(k)s/403(B)s, IRAs, taxable accounts, etc. By focusing on total return, investors have more control over when they can collect income and where that income can come from. Those dividends come no matter what, whereas a total return-focused investor can potentially limit their taxable liability.
Part of a One-Two Punch
With that in mind, focusing on total returns could be better for your bottom line. Dividends remain a powerful piece to the total return pie; you need a dose of income stocks when looking at the big picture. The key is not to just focus on their payouts, but how that payout fits into your entire portfolio to generate the income you need as a whole.
Image courtesy of hin255 at FreeDigitalPhotos.net
