Although financial advisors use a variety of means — ladders of guaranteed investment certificates, systematic withdrawal or guaranteed minimum withdrawal benefit programs — to replace retired clients’ employment income, dividend yields continue to be one of the most common approaches.

This strategy has proven attractive because it appears to satisfy the criteria for retirement-oriented investing: income, capital preservation and liquidity.

But as markets have evolved and the retirement-investing landscape has shifted, this strategy may prove less effective, warns Rod Greenshields, consulting director, wealth-management solutions, Seattle-based Rus-sell Investments Group, in his paper entitled Be Wary Of Chasing Dividend Yield For Income. Instead, the paper suggests, advisors need to frame the income-replacement issue more through the lens of total return: the sum of both dividends and capital appreciation.

A few decades ago, it was reasonable to invest in a broadly diversified pool of stocks and still earn a healthy dividend. From 1979-85, the average yield for the Russell 1000 index exceeded 5.5%.

Since then, however, dividend yields have dropped significantly. The lowest range was during the 1998-2002 period, when yields averaged less than 1.5%. Although the most recent period (2004-10) shows a modest rise in dividends to almost 2.3%, relying on dividends to provide a level and adequate income simply hasn’t been as easy as it used to be.

And although it’s difficult to predict the exact dividend policies that companies will adopt in the coming years, Greenshields’ paper says, it’s unlikely that dividends will be as high or as stable as they have been in previous decades.

As interest rates rise, which they will eventually, dividend-paying stocks become less attractive because their yields are likely to lag the yields from high-quality corporate debt.

What’s worse, when the extension to the Bush administration’s tax cuts in the U.S. expires in 2012, dividends from U.S.-based companies could again be taxed at the standard rate, which is how they were taxed for much of the bull market of the 1980s and 1990s. And existing tax advantages of Canadian dividends could also come under pressure.

To achieve a dividend yield level even close to what a broadly diversified portfolio could have delivered a few decades ago, [your clients’] portfolios would need to be concentrated in no more than the highest 10% of dividend-paying stocks, as represented by the Russell 1000 index.

However, as 71 of the top-yielding securities in the Russell 1000 index are in the financials and utilities sectors, pursuing this strategy would allocate almost three-quarters of such a portfolio to these narrow sectors. And, as history has proven time and again, unexpected events can devastate narrow areas of the market and individual securities.

As more clients enter retirement and must replace substantial proportions of their working years’ income using their investment portfolios, a dividend-yield strategy is likely to fall short, Greenshields’ paper notes. There may simply be no alternative to adopting some form of total-return investing. IE