Total Return Investing Is A Trap To Avoid - Here's Why

by: Treading Softly

Total return has become a buzzword for investors and writers.

Total return looks backwards, not forwards.

Value investors don't care about dividends.

Dividend investors don't focus on value fluctuations.

Total return is not the key metric to focus on.

Total Return Investing Defined

Investors keep hearing the term "total return" or "total return investing" thrown around casually by most investment gurus, authors or other investors, but few know what it means.

Investopedia defines total return as the following:

Total return, when measuring performance, is the actual rate of return of an investment or a pool of investments over a given evaluation period. Total return includes interest, capital gains, dividends and distributions realized over a given period of time.

Breaking into simplistic terms, total return is a holistic approach combining all gains received from the sale of the security as well as any dividends, distributions or income received from it. The key here is that to accurately determine total return, the investment must be sold. By nature, total return is a rearward-facing metric, not forward.

Total Return's Built-in Limitation

Outside of simply being a rearward-facing metric, analysts and CEO's will try to sell investors on future potential total return. They often leave off the word "potential" and tout the total return for a given security over the next year. Total return as a holistic metric is forced to assume all investors have one goal: make as much money as possible. This limiting the goals of all investors into one tunnel is myopic in nature. All investors have unique goals, and all investors have unique situations. Lumping all investors into one metric and declaring it superior is faulty at best and arrogant at worst.

The investing community can more correctly be grouped into two major types of investors - with a multitude of sub-types and styles. These types are: Value investors/traders and Dividend investors.

Value-Driven Traders

Value investing focuses on the changing value of any given security and seeks the majority of their return from capitalizing on these gains. Value investing can return large sums of money in a short time but requires the individual to actually be a trader, not an investor. If you are forced to sell a security to achieve real-world capital gains, then congratulations, you're a trader. There is nothing wrong with being a trader, although many instantly picture day traders actively trading on speculative stocks - this isn't the primary case for traders.

All value investors have only paper gains until they sell out of their position. Meaning they have absolutely zero returns until they sell. These investors are hurt the worst when a recession or bear market hits if they are forced to sell securities at rock-bottom prices when life events demand the money - like retirement. Conversely, they see monumental gains when a security achieves success that dividend investors would avoid due to a lack of dividends.

Dividend-Focused Investors

Dividend-focused investors cover all types or sub-categories of dividend investing. This includes our dividend growth investors, immediate income investors and regular ol' "I don't care what it does as long as the dividend is covered" investors. These investors have less concern about the day-to-day value of their stocks, so long as the dividend is covered or growing. This type of investor receives regular real-world returns as their dividends trickle or pour into their account. If one of their securities were to bottom out and become worthless, a value investor would have nothing to show for it but losses, whereas a dividend investor would have the cumulative total of their dividends as a return.

Total Return Shouldn't Determine Your Investing Choices

As an investor, you need to determine your goal for your purchasing of any security, but total return shouldn't be it. Why? Because it's rearward-facing. Dividend investors should focus on maximizing their dividend stream - which total return completely ignores, except for comparing it dollar to dollar with capital gains once the security is sold. If you want dividends, you won't sell a properly performing security - never finalizing a proper total return equation.

Value investors generally won't care about that 3% dividend others cherish if they think a non-dividend paying stock is set to double in a year, or five. So total return is moot to them.

Total return is a compromising position used to allow investors to compare their investment choices assuming all they care about is the total amount of cash earned - in the end. Remember, you only have a total return if you've sold your entire position in a security, since it's not "total" unless you're totally done.

One great example of a security touting itself as a total return stock is none other than the highly popular Brookfield Infrastructure Partners (BIP). BIP's factsheets highlight its total return over an extended period as a reason to invest in the company. But throughout 2018, the stock's total return (from 1/1/2018 to 1/1/2019) has been dismal.

Chart BIP data by YCharts

But investors would be deceived if they used total return as their focus with BIP. In all reality, BIP is a fantastic dividend investor stock. Dividend investors with a long-term window of investment will reap massive benefits from the company's consistent distributions and its long history of steady increases.

Value investors, who don't care about the just over 3% benefit from dividends, should focus elsewhere in the market to capture better gains. Both Amazon (AMZN) and Netflix (NFLX) offer better value investment returns versus BIP.

Chart AMZN data by YCharts

Value investors can even be readily deceived by using total return into thinking investments will increase in value over a given time frame (remember, this truly is screen for a hopeful "potential" total return). Take Oxford Lane Capital Corp. (OXLC), which invests in collateralized loan obligations, CLOs, which provide a steady high yield income.

Chart OXLC data by YCharts

Since total return includes dividends, this metric is skewed by high yield options into looking attractive, when it will never meet a value investor's focus.

Meanwhile, dividend investors will enjoy the minimal capital depreciation while collective the steady distributions.

Total return may be a single screening metric to help you locate securities that have positively moved in a holistic way in a predetermined past time frame, but it fails to capture the real-world motivation of 99% of investors. It is far from being the only metric that counts for evaluating investment choices.

Find Your Purpose and Invest that Way

The most common day-to-day advice I give out to my peers is to find their purpose and focus on that. In investing, my encouragement to investors is to figure out what your investing goal is and ignore what doesn't apply to it. If you want to receive a regular income stream that doesn't depend on you selling out of positions, look to dividend investing metrics. If you want to achieve a large end-game cash pile and don't need dividends along the way, consider value investing. Don't let others fool you. Total return is one metric. One compromised, holistic, myopic metric.

Disclosure: I am/we are long BIP, OXLC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.