In just the last six months, the convergence of historically low Treasury yields, increasing stock market volatility, and the looming threat of a recession has been creating a challenging time for income-seeking investors.
We believe that it is critically important for retirees and pre-retirees to understand the risks of reaching for higher yields and to consider alternative strategies for creating lifetime income sufficiency.
Right now, a rising-dividend strategy may be the best option for weathering the storm while generating a sustainable and growing income.
Where Can Investors Go for Yield?
Since the 2008 financial crisis, income-oriented investors have been challenged by historically low yields that have lasted much longer than predicted. Even as the Federal Reserve began to ratchet up rates in 2015, 10-year Treasury yields have not caught much upside traction. They have recently slipped below the yield inversion line, which, historically, has been a harbinger of an oncoming recessionary cycle.
The good news is inflation has been largely held in check, hovering near the low end of the Fed’s 2% to 2.5% target range. The bad news is that, at 1.9%, inflation is currently outpacing the 10-year Treasury yield, which has fallen to 1.69% as of October 31, 2019. But for retirees, costs for housing (independent living facilities), healthcare, and leisure can rise at a much faster rate.
So, if that’s the current environment and foreseeable outlook, where can investors go to source income outside of Treasuries or CDs?
Corporate Bonds. While corporate bonds may offer higher yields, risk in the credit markets is on the rise. If you believe interest rates will rise in the future, you can expect corporate bond prices to decline. However, the real risk in holding corporate bonds is in the potential deterioration of the credit markets themselves. Low rates over the last decade have enticed companies to pile on debt to the tune of $9 trillion by 2018. Another $15 trillion of corporate debt will need to be refinanced over the next several years in the midst of market volatility.
Preferred Stocks. Preferred stocks are generally coveted by yield-seekers for their high yields and relative safety as compared to common stocks. However, they perform similarly to bonds in that they are interest-rate sensitive and don’t have the upside potential of common stocks. In addition, the dividend payout on preferred stocks is typically fixed, whereas the dividend on common stocks has the potential to increase.
Real Estate. Real estate has long been a popular income-producing investment, considered to be stable with the potential for increasing cash flow and capital appreciation. However, owning real property has its challenges for people who never envisioned becoming a landlord. Real estate investment trusts (REITs) are a good alternative. However, REIT share prices are also interest-rate sensitive, tending to fall when rates rise as well as during real estate market downturns.