Recent events have caused many investors to seek low-risk investments. But interest rates on "safe-haven" investments have been abnormally low, meaning investors who have relied on them for income in the past are now being forced to seek more risky investments in an attempt to maintain a steady stream of income.
For example, ten years ago, 10-year Treasury notes were yielding approximately 3%. Twenty years ago, they were approximately 5%. Today, the yield on the 10-year Treasury is 1.5%.
If income is a priority for your investment portfolio, consider these 3 different options during these unprecedented times.
Dividend stocks represent companies that have historically paid out regular dividends (payments to investors). Dividend stocks are usually well-established/blue chip companies with a track record distributing dividends to shareholders.
The current tax environment is favorable for those who receive qualified dividend income. The highest qualified dividend income tax is 20% for single filers with incomes greater than $441,450 ($496,600 for married couples filing jointly). Bond interest income, on the other hand, is taxed at your ordinary income tax rate. For example, if your marginal income falls between $414,701 and $622,050, the ordinary income tax rate is 32% (12% higher than qualified dividend income).
Even though qualified dividend income is taxed at a lower rate, dividend stocks are more volatile in comparison to bonds. That is, they have a riskier investment profile. In addition to higher price volatility, there’s also the potential for dividend cuts in a weakening economy, which can be a "double whammy" to investors who may experience both a reduced stock price, and reduced dividends.
While yields on high-quality bonds have gone down, yields on lower-quality bonds have gone up. For example, as of September 29th, the yield on the ICE U.S. High-Yield 100 Index (a lower quality bond index) was 3.4%, while the Barclays Bloomberg US Aggregate Index (a higher quality bond index) was 1.6%. Investing in high-yielding bonds gives investors the opportunity to increase their income return in an environment where high-quality bonds may be underperforming.
However, keep in mind that high yields come with higher risk, as these issuers may have a difficult time paying coupon and principal payments in a weakening economy. Higher-yielding bonds will not provide the same level of diversification in your portfolio as those of high-quality bonds, and your portfolio will be inherently riskier.
Although yields on cash/cash equivalents have been anything but exciting, they have been close to what intermediate bond investors are earning today. According to bankrate.com, many high yield savings accounts are yielding approximately 0.5%, which is equivalent or better than the yields on many bond funds. Not to mention, there is no volatility in your cash balance, something that bondholders do not experience.
Although cash investments are sometimes described as “risk-free,” there is the risk of inflation and opportunity cost. In high inflation environments, rising prices reduce the purchasing power of cash ($1 buys less of a good or service in a rising price environment). Investors who hold too much cash may also be faced with an opportunity cost of foregoing higher returns if they had invested in higher-performing investments.
As you search for higher yields, you want to ensure that the investment choices align with your required returns, time horizon to invest and your risk tolerance. Even though we are in uncharted waters, sound investment decisions are more important than chasing yields.
Looking for help with next steps? Talk to our advisors at Finwell to help understand all of your options and create a plan to reach your goals. Get started by emailing email@example.com today.
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