What is the Other Behavioral Gap:

 If you’ve been investing for a while, you’re likely familiar with the first major behavioral gap: emotional investing that is driven by fear or greed. These forces drive you to buy high and sell low. It’s a pattern that often shows up when market fluctuations cause knee-jerk reactions. But what about those who have managed to move beyond that trap and are now at a stage where the real challenge is figuring out how to spend the money they’ve worked hard to save?

Let’s explore the difference between two key investment philosophies: living off investment income versus a total return approach.

The Siren Song of “Investment Income”

Let’s talk about the income investing approach first. The basic idea is simple: only spend the dividends from your stocks and the interest from your bonds. Leaving your original investment (your principal) completely untouched — letting it sit there forever (in theory).

This idea has a powerful pull for a lot of people, and it makes perfect sense: It feels incredibly safe. It feels responsible. It feels like you’re living within your means, only spending the “earnings” your money makes, much like living off rental income but never selling the property. But prioritizing that feeling of security could be holding you back.

How Income Investing Can Lead to Behavioral Traps

Mental Buckets: The Psychological Pitfall of ‘Do Not Touch!’

We’re all guilty of mental accounting. We put money into different psychological buckets. Money earned from work goes here. A tax refund goes there. And investment income? That often goes into the “spending money” bucket – easy come, easy go (relatively). But the principal, the main investment? That goes into a do not touch bucket, which can make us super hesitant to sell any part of our investments, even when it makes total sense from a financial planning perspective.

Loss Aversion: Hating Losses More Than Loving Gains

Income-focused investors are also more likely to fall prey to loss aversion, a psychological bias where the pain of losing is felt more strongly than the pleasure of winning. Some investors resist selling holdings that are down to avoid realizing a loss, even if reallocating could improve their overall outcome. Others avoid selling winners, worried they’ll miss out on further gains. In both cases, emotion—not strategy—is driving the decision. And when income becomes the sole focus, investors may unknowingly take on more risk by concentrating in high-yield assets instead of maintaining a diversified, total return approach.

Framing matters: Look at Both Sides of the Coin

When you focus only on the income your investments produce—like dividends or interest—you’re missing a critical part of the picture: how the underlying value of those investments is changing. Capital appreciation or depreciation impacts your total return just as much as income. It’s like judging a business purely on quarterly revenue without considering its profitability or the value of its assets. You need both sides to make informed decisions.

Total Return Club: Embracing Flexibility (and New Biases)

The total return approach is a bit different. It says, “Look, money is money.” Whether it’s from a dividend payment, interest, or the profit you make from selling an investment that’s gone up in value (a capital gain), it’s all part of the total money your portfolio has generated.

The goal here is to grow the entire pie as much as possible, while managing risk. When you need cash to live on, you take it from wherever it makes the most sense at that moment. Maybe you take some income, maybe you sell a few shares that have done well. The source matters less than ensuring the overall portfolio stays healthy and on track to support you.

Understanding Behavioral Biases in Total Return Strategies

Despite its flexibility, the total return approach isn’t free from psychological challenges. The most common hurdle is spending principal. In contrast to living off just the income, the total return approach requires you to dip into your portfolio’s principal (or capital) to fund your retirement needs. This can be an emotional challenge, particularly if you’ve spent years thinking of your principal as untouchable.

Additionally, total return investing exposes you to sequence of return risk—the danger of withdrawing from your investments during a period of poor market performance. If the market is down when you begin taking withdrawals, you might be forced to sell investments at a loss, which can have a long-term negative impact on your retirement.

Behavioral Economics: Why the Total Return Approach Can Be Harder (But Smarter)

While the total return approach offers flexibility, it can be harder for investors to implement because of the psychological discomfort associated with selling your principal. It’s natural to want to preserve your original capital, but failing to do so can prevent your portfolio from growing at the pace needed to maintain your standard of living.

Understanding concepts from behavioral economics, like prospect theory (which basically shows that we feel the pain of a loss more strongly than the pleasure of an equal gain), helps explain why the simple, predictable nature of income investing can feel more appealing than the more variable path of total return, even if total return might be better for the long haul.

The key to overcoming this psychological barrier is to reframe how you view your portfolio. Instead of thinking about your investments in terms of income versus principal, consider your portfolio as a whole, working together to fund your long-term goals. This mindset shift allows you to make more balanced decisions that are less influenced by short-term emotions—they’ll also help you avoid a regret gap down the line.

Practical Steps to Build a Flexible Spending Plan

So, how can you overcome these behavioral challenges and make the most of your retirement savings? Here are some practical steps:

1.      Embrace the Total Return Mindset (like, yesterday)

 Start thinking about your investments in terms of total return rather than relying solely on income. This will help you make better decisions when the time comes to transition into retirement.

2.      Build Flexibility Into Your Spending Plan

Avoid locking yourself into rigid withdrawal rules. Instead, create a spending plan that gives you room to adjust based on market conditions.

3.      Automate Your Cash Flow: Reduce Emotional Decision-Making

Set up automatic withdrawals from your portfolio so that you’re not tempted to make emotional decisions during periods of market volatility. This helps to remove the impulse to buy high and sell low.

4.      Rebalancing: A Key to Long-Term Security

Rebalancing your portfolio regularly – selling some of what’s done well to buy more of what hasn’t – is crucial. (This directly involves selling appreciated assets.) Get comfortable with this. It’s not “selling winners”; it’s smart portfolio management. It helps you manage risk and stick to your plan.

5.      Crafting a Comprehensive Plan with Your Advisor

 Your “plan” needs to be more than just a portfolio. A real financial plan connects your investments with your spending needs, taxes (remember: capital gains and income are taxed differently), and other income sources like Social Security. A good advisor helps you build this integrated plan—one that keeps you grounded when the market isn’t.

6.      Focus On What You Can Control

You can’t predict the market—so stop trying. But you can control your asset allocation, your savings rate, and your spending. Focusing on these factors not only improves outcomes but also reduces anxiety. When markets get choppy, having clarity on what you control can help drown out the noise of your own behavioral biases.

The Path Forward

So, while the idea of just living off investment income has a nice, neat feel to it, the total return approach has historically offered more flexibility, better diversification, and a higher probability of your money outlasting your goals. By being aware of the psychological traps and having some practical ways to handle them, you can navigate the complexities of using your investment portfolio to live on with a lot more confidence and build a more secure portfolio and future.

Ready to navigate your retirement strategy with confidence? Connect with us to schedule a consultation with one of our expert advisors.