October 21

This is not your Fathers portfolio


As seen in the Bradenton Herald October 27, 2020

Before I even knew what a stock was, I had heard many investing maxims that had been passed down through our family.  Statements like “never touch the principal in a portfolio” or “buy and hold and live off your dividends” or “don’t eat your seed corn”.   These are shared wisdoms of Income investors – a system of investing that says you should build a portfolio to maximize annual earnings through dividends on stocks and interest from bonds while never touching your principal.  These maxims had been passed down to my father from his father who had been fortunate enough to inherit a little GM stock that ultimately helped pay for my education.  Growing up in Atlanta I had many friends whose families had bought Coca Cola stock early and their families were able to supplement their incomes with the dividends. 

Over the years I was indoctrinated with income investing and tips on finding yield in bonds and stocks.  A common statement would be “As long as they keep paying their dividend, I don’t really care what the stock price does.” It would take some time before I would learn that this sage wisdom was antiquated and potentially dangerous to the well-being of a modern retiree.  Yet I still hear this advice spouted daily by media outlets and individual investors.

You probably have heard your own share of success stories of investors who were able to retire and live comfortably off of their stock dividends, and possibly even fund their retirement spending solely from interest payments from their bond portfolios. While that may have worked for some in your parents’ or grandparents’ generation, those stories are becoming rarer as Interest rates have fallen dramatically over the past 40 years.  In 1981, the yield on a ten-year Treasury bond peaked at 15.84%, while on October 19, 2020, the ten-year Treasury yield was just 0.761%.  In 1981 the dividend yield on the S&P 500 was 5.36%, while it currently sits at 1.75%.

Clearly a reliance on a portfolio of the S&P 500 with a mix of ten-year treasuries is not going to generate sufficient income for most retirees unless they are very frugal or have been fortunate enough to save a sizable portfolio relative to their spending needs.  I recall in the 1990’s as yields were continuing to drop this tended to cause investors to stretch into more corporate and high yield bonds and possibly preferred stocks to increase their income.  By the 2000’s total return was becoming more common but the steadfast “never touch principal” income investors were adding illiquid and expensive investments like annuities and non-traded vehicles to maintain their income standards.  In the latter 2010’s to today it would seem that a heavier reliance on dividend stocks has become more the norm.

My primary concern with income investing today is that it can be hazardous to your wealth.  It forces you to concentrate your investments in a narrow band of income producing investments that violates the first rule of prudent investing – maintain a diversified portfolio. 

The alternative is to allow for the investor to touch the principal and in doing so you have allowed them to create a more resilient portfolio. 

Spending principal sounds dangerous until you understand the dividend irrelevance theory first discussed in 1961 by Nobel laureates Merton Miller and Frank Mogdigliani.  It basically breaks down equity returns into 2 components:  capital gains (price increase) and dividends.  Add them together and you get the total return for a stock.  So if you have a $10 stock that pays a $2 dividend and you spend that dividend it is no different from a stock that increases from $10 to $12 and you sell $2 to generate the same income.  In both cases you have $10 worth of stock left with $2 to spend.  The dividend was irrelevant. 

Investing in this manner is called Total Return Investing.  It allows you to put together the best portfolio without worrying about yield and inadvertently concentrating your portfolio to greater risk in the effort to increase the income.  Less diversification means more dispersion which reduces the reliability of your outcome.  Total return further allows you to take control of your taxes by deferring unnecessary income in years when it is not needed. 

It may sound contrary to what our father’s told us, but a total return approach can mitigate some of the risks of a wholly income-oriented portfolio, provide more flexibility and can help create sustainable growth for a longer retirement.

Gardner Sherrill, CFP, MBA, is a certified financial planner with Sherrill Wealth Management. To learn more, visit sherrillwealth.com, a Bradenton wealth management firm specialized on living in retirement.

The opinions expressed in this material are not intended to provide specific advice or recommendations for any individual.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and my not be invested into directly.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all industries.

Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.


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About the author

Gardner is a CERTIFIED FINANCIAL PLANNER and principal of Sherrill Wealth Management in Bradenton, Florida. He has spent 20+ years in the wealth management field helping families negotiate the various obstacles and opportunities that retirement provides them. Read More

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