How to Use a Total-Return Approach for Retirement Income

September 23, 2021 Rob Williams
Dividends and interest aren't likely to be enough to cover most investors' income needs. Planning for some asset sales may be more realistic.

What's the most effective way to draw an income from your savings, even as you keep those savings invested for future growth?

A common assumption is that you just need to make sure your portfolio generates enough interest and dividend income for you to live on, and you'll never have to sell anything. However, as both an investing strategy and an income plan, this may not be realistic for most investors. On one hand, chasing returns from interest and dividends can be risky. On the other, focusing just on yield may cut you off from other sources of cashflow in your portfolio. 

We suggest retirees think more broadly, and build a portfolio that can provide income, growth potential, and liquidity. While interest and dividends may be an important source of return, we encourage investors to think of their whole portfolios—including cash balances and asset sales to capture capital gains—as a source of funds.

We call it the total return approach to investing and generating cash flow in retirement, and recommend it to most investors. Here's how it works.

The building blocks

The basic retirement portfolio consists of three main asset classes: Stocks, bonds, and cash investments. (Of course, there are many other kinds of assets and sub-categories within each asset class, but we'll focus on these three for now.)

Each asset class has a unique role.

  • Stocks can deliver price growth over the longer term and pay dividends.
  • Bonds can generate income through fixed coupon payments and help stabilize a portfolio during a stock market downturn.
  • Cash and other short-term investments such as bank deposits and short-term bonds or CDs offer a high level of stability, as well as liquidity and flexibility when needed.

How you allocate across these classes will depend on your plans and should be structured to provide income when you need it, as well as growth for the long term. We recommend keeping a year's worth of your expenses in cash, two-to-four years’ worth of expenses in a short-term reserve comprised of cash and short-term bonds or bond funds, and the remainder invested for the long term.

The overarching goal is to have a portfolio that delivers income, even as it grows at a higher average rate each year than the portion you plan to withdraw. (So, if you're using the 4% rule for your withdrawals, you'd aim for a growth rate above that.)

Now for an example.

Total return strategy in action

The short version is: Interest and dividend payments pour into your cash pot throughout the year. Take your targeted annual withdrawal from there. (If you have enough, great! You've met your income needs for the year through dividends and interest alone.) Then rebalance your portfolio to your target allocation. This should be part of your regular portfolio maintenance, but if you still need cash, you can collect it after rebalancing.

So, let's say you're retiring with a $1 million portfolio, in a moderate asset allocation that includes $50,000 in cash, and you hope to spend $100,000 each year of your retirement. We'll also assume your Social Security payments and an annuity will generate $50,000 every year. That means you'll need your investment portfolio to generate the other $50,000.

The table below shows how this hypothetical portfolio would evolve over the course of a year. The Income Return column records how much investment income, or yield, each part of the portfolio would generate. That sum is collected as cash, which you can see would have boosted your cash balance from $50,000 at the start of the year to $69,250 at the end.

A sample total-return based spending plan

A sample total-return based spending plan
Investment: Purpose  Start of the year  End of the year
Beginning amount (portfolio weight)  Income return (%)  Total return (%)  Ending amount (portfolio weight)
Cash: Current spending  $50,000 (5%)  1.5%  1.5%  $69,250 (6.3%)
Fixed income: Capital preservation and income  $350,000 (35%)  2.0%  8.8%  $373,800 (33.9%)
Large-cap equities: Growth and income  $350,000 (35%)  2.0%  15.1%  $395,850 (35.9%)
Small-cap equities: Growth and income  $100,000 (10%)  1.5%  9.3%  $107,798 (9.8%)
International equities: Growth and income  $150,000 (15%)  2.0%  6.9%  $157,323 (14.3%)
Total  $1,000,000 (100%)  1.9%  10.4%  $1,104,021 (100%)

That means you already have enough to plug the $50,000 gap in your spending plan for the coming year and are almost halfway to refilling your 5% cash allocation.

Now it's time to rebalance. As you can see in the End of Year Amount column, investment income and capital gains have boosted your $1 million portfolio to $1,104,021—and pushed your allocations away from their target weights. So, the next step is to buy investments that are below target—for example, in addition to replenishing your 5% cash allocation, you would also buy bonds to bring your fixed income allocation back up to 35%—and sell investments that are above target—for example, you would sell large-cap equities to bring that allocation back down to 35%.

The table below shows the results. With this approach, you not only keep your target allocation on course, but you also go into the next year with a bigger portfolio than you had the year before. Notice, for example, that your 5% cash allocation is now $52,701, reflecting the fact that your overall portfolio is worth more.
Of course, your portfolio won't always be bigger. When the market is up, you may have more. When it's down, you may have less.

How to restore your target asset allocation by rebalancing

How to restore your target asset allocation by rebalancing
Investment  Amount after $50,000 withdrawal from cash  Amount sold or purchased  Amount after rebalancing  Portfolio weight (%)
Cash  $19,250  $33,451  $52,701  5%
Fixed income  $373,800  –$4,893  $368,907  35%
Large-cap equities  $395,850  –$26,943  $368,907  35%
Small-cap equities  $107,798  –$2,396  $105,402  10%
International equities  $157,324  $780  $158,103  15%
Total  $1,054,021  $0  $1,054,021  100%

Yield first

It's worthwhile to contrast this approach with one where you rely entirely on dividend and interest income in the hope that you'll never have to sell assets for cash. Believe it or not, that kind of rigidity can be risky. Why?

  • You may stretch for yield. An inflexible focus on generating as much yield income as possible could tempt you to focus too much on historically higher-yielding—but riskier—investments, such as high-yield bonds, master limited partnerships (MLPs), and real estate investment trusts (REITs). Though these can be appropriate in the right circumstances, our research shows that certain higher-yielding investments can expose you to equity-like risk and leave you with a more volatile portfolio. Investing too much in such volatile assets could mean that in a down year, you'd end up having to tap the principal you were trying so hard to preserve.
  • You may fail to diversify. Most portfolios should have a mix of growth and income investments. The growth piece offers the potential for the principal to appreciate faster than inflation. The income piece, of course, provides money to live on. Trying to eke out a reasonable living from dividends and bond income may necessitate dedicating a disproportionate share of your portfolio to fixed income, making the overall mix less diversified and paradoxically—since bonds are often viewed as safe, conservative investments—riskier because it may not keep pace with inflation.
  • You may not generate enough to support your lifestyle. Our hypothetical $1 million portfolio was able to generate a $50,000 retirement "paycheck" through a combination of dividends, interest, and asset sales. Removing asset sales from that calculation would leave you well short of your funding goal—which could translate to a very different retirement lifestyle.

Get the facts—and help

Again, the goal of a total return approach is growing and producing enough income to outpace your spending needs. That assumes you're starting out with an appropriate mix of investments to provide properly diversified sources of return. 

To make sure you're starting from a good place, consider sitting down with a professional to determine how much income your portfolio is likely to produce each year through interest and dividend payments. Compare that to your yearly income needs. The difference between those two amounts is what you'll cover through the sale of assets and rebalancing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when a nonretirement account is rebalanced, taxable events may be created that may affect your tax liability.

Investing involves risk, including loss of principal.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Small cap investments are subject to greater volatility than those in other asset categories.

Real Estate Investment Trusts (REITs)-Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and credit worthiness of the issuer.

Master Limited Partnerships (MLPs)-Investments in securities of MLPs involve risks that differ from an investment in common stock. MLPs are controlled by their general partners, which generally have conflicts of interest and limited fiduciary duties to the MLP, which may permit the general partner to favor its own interests over the MLPs.