# Total Return: Smoke and Mirrors?

## A new math, new yardstick needed

### Steve Selengut

Mr. Selengut is a private investor and a contributing editor to LIFE&Health Advisor. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at sanserve@aol.com.

Just what is this “total return” hoop that investment managers are required to jump through? Why is it mostly just smoke and mirrors?

#### Here’s the formula:

• Total Income + (or -) Change in Market Value – Expenses = Total Return — the ultimate test for any investment portfolio. Applied to income purpose portfolios, it is really close to nonsense, and confusing to most investors.

Remember John Q. Retiree? He was the guy with his chest all puffed up one year, bragging about the 12% “Total Return” on his bond portfolio. Secretly, he wondered about having only 3% in actual spending money.

A year or so later, he’s scratching his head wondering how he’s going to make ends meet with a total return that’s approaching zero. Do you think he realizes that his spending money may be higher?

What’s wrong with this thinking? How will the media compare mutual fund managers without it?

Wall Street doesn’t much care. They set the rules and define the performance rulers, and they say that income and equity investment performance can be measured with the same tools. They can’t, because their investment purposes are different.

#### A different yardstick

If you want to use a ruler that applies equally well to both classes of security, just change one piece of the formula and give the new math a name that focuses on the actual purpose of income investing — the spending money.

We found this old way of looking at things within “The Working Capital Model”; the new and improved formulae are:

• For Fixed Income Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money!
• For Equity Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money!

Yes, they are the same, and divided by the amount invested, they produce a Total Realized Return number. The difference is what the investor elects to do with the spending money.

So if John Q had taken profits in year one, he could have spent more, or added to his income production. You just can’t spend (or reinvest) “Total Return”.

Changes in the market value of investment grade income securities are totally and completely irrelevant, 99% of the time

We’ve taken those troublesome paper profits and losses out of the equation entirely. “Unrealized” is “un-relevant” in a properly diversified portfolio comprised only of investment grade, income producing securities.

Most of you know of Bill Gross, the Fixed Income equivalent of Warren Buffett. He manages a humungous bond mutual fund, but how does he invest his own money?

According to a NYT Money and Business article by Jonathan Fuerbringer (January 11, 2004), he’s “out” of his own Total Return fund and “in” Closed End Muni Funds paying 7.0% tax free. (Must have read “The Brainwashing of the American Investor”.)

Fuerbringer doesn’t mention the taxable variety of CEF, then yielding roughly 9%, but they certainly demand a presence in the income security bucket of tax-qualified portfolios like 401ks. Sorry, can’t do that now. The omniscient DOL says the net/net income isn’t nearly as important as the Expense Ratio….

Similarly, Mr. Gross advises against the use of the non investment grade securities (junk bonds, etc.) that many fund managers sneak into their portfolios.

But true to form, Mr. Gross is as “Total Return” Brainwashed as the rest of the Wall Street institutional community, as he gives lip service validity to speculations in commodity futures, foreign currencies, derivatives, and TIPS.

#### Inflation & buying power

Inflation impacts buying power, and the only way to beat it is with higher safe income. If TIPS rise to 5%, REITS will yield 12%, and preferred stocks 9%, etc. No interest rate sensitive security is an Island!

As long as financial intellectuals remain mesmerized with total return numbers, investors will be the losers.

Total Return goes down when yields on individual securities go up, and vice versa. This is a good thing.
Total Return analysis is used to engineer market timing decisions between fixed income and equity investments, based on statements such as: “The total return on equities is likely to be greater than that on income securities during this period of rising interest rates.”
Investors have to commit to the premise that the primary purpose of income securities is income production… this requires a focus on spending money.

If these three sentences don’t make complete sense to you, you need to learn more about income purpose investing:

• Higher interest rates are the income investor’s best friend. They produce higher levels of spending money.
• Lower interest rates are the income investor’s best friend. They provide the opportunity to add realized capital gains to total spending money and to total working capital.
• Changes in the market value of investment grade income securities are totally and completely irrelevant, 99% of the time.