You may recall one of your grandparents admonishing you to “never spend your principal”, an idea firmly planted in them, perhaps during the Great Depression when few people invested in stocks. Today in a world of low interest rates and relatively high stock appreciation, never spending the principal can severely limit your lifestyle with the result of being overly generous to your heirs.
Your Returns Are Total
When we think about returns, we usually refer to the Total Return of a portfolio. The total return is derived by adding together the income return (or yield), usually dividends and interest, to the portfolio’s appreciation return.
The income return in today’s portfolios is usually much smaller than the appreciation. For example, the yield from dividends and interest of our current 60/40 portfolio (60% stocks and 40% bonds) averages approximately 3% per year. In addition to the yield, appreciation of the portfolio has averaged about 6% per year. The Total Return would therefore be 9%, which is simply the 3% yield plus 6% appreciation.