For generations, many retirees were given a seemingly simple piece of investment advice: build a portfolio of dividend-paying stocks, spend the dividends and never touch the principal.

It sounds prudent. If you own $1 million of investments generating $40,000 in dividends each year, you can spend that $40,000 while leaving your $1 million portfolio intact. At least, that’s how the theory goes.

Unfortunately, investing doesn’t quite work that way.

One of the most common misconceptions about dividends is that they are an investment return separate from the value of the stock.

Suppose you own a stock worth $100 per share and the company pays a $4 dividend. All else being equal, once that $4 leaves the company and goes into your pocket, the stock is worth about $4 less.

Economically, receiving a $4 dividend isn't dramatically different from owning a $100 stock, selling $4 worth of it and keeping the remaining $96 invested.

In both cases, you have converted part of your investment into cash.

This is why retirees should focus on total return — the combination of dividends, interest and investment appreciation — rather than dividends alone.

Another common belief is that spending dividends preserves principal while selling shares depletes it.

Consider two retirees who each begin the year with a $1 million portfolio. One receives $40,000 in dividends and spends them. The other owns investments that pay no dividends but appreciate to $1,040,000. The second retiree then sells $40,000 of investments.

Both finish with about $1 million invested.

The first retiree “lived off the dividends.” The second “sold principal.” Economically, however, their situations are nearly identical.

The number of shares you own isn’t what ultimately determines your financial security. The value and sustainability of your portfolio do.

The desire to generate enough dividends to cover retirement spending can also lead investors into a dangerous trap: chasing yield.

A retiree who needs $50,000 from a $1 million portfolio might conclude that he or she needs investments yielding 5%. But building a portfolio around a specific dividend target can result in concentrating money in certain companies or sectors simply because they pay higher dividends.

An unusually high yield can also be a warning sign of financial trouble, and dividends are never guaranteed. Companies can, and do, reduce or eliminate them.

In a taxable account, dividends can create taxable income whether you need the money or not. Selling shares provides more control over when you realize gains and how much taxable income you generate.

That flexibility can be valuable for retirees managing their overall tax situation, including potential effects on Social Security taxation and Medicare premiums.

Not at all.

Dividend-paying companies can be excellent investments, and dividends are an important component of total return. The mistake is treating dividends as fundamentally different — or inherently safer — than the rest of your investment return.

Rather than designing a portfolio simply to produce enough dividends to cover expenses, retirees should focus on building a diversified portfolio appropriate for their financial plan and creating a sustainable withdrawal strategy from its total return.

Sometimes those withdrawals will come from dividends and interest. Other times, they may come from selling investments that have appreciated.

Neither is inherently better simply because one is called “income” and the other is called “principal.”

Ultimately, your portfolio doesn't know whether the dollars you spend came from a dividend check or the sale of a few shares.

And neither does the grocery store.

Collin Randall, CFA, CFP, is a financial adviser at Randall & Associates Wealth Management, with offices in Butler and Warrendale. Randall & Associates Wealth Management Inc. is a registered investment adviser and does not provide any legal, accounting or tax advice. The opinions expressed here reflect the judgment of the author as of the date of the article and are subject to change without notice.