Low Yield Getting You Down?
It's no secret that the prolonged low-interest-rate environment has been enormously challenging for millions of savers and retirees who are struggling to generate income from their investment portfolios.
But it's also no secret that income and risk tend to work in tandem: The riskier the investment, the greater the potential income.
If, in addition to your core bond portfolio, you want to stick with cash investments like certificates of deposit (CDs) and savings accounts, you'll need to be willing to accept near-zero yields, at least for the foreseeable future. If you want to increase your investment income by making some changes to your portfolio, you can try to do that, too—but you have to be willing to accept some more risk.
The investments we'll be talking about here each come with their attendant risks, and we don't recommend venturing into them before you've nailed down some basics: an asset allocation that makes sense for your investment horizon and risk tolerance; a cash cushion for safety and liquidity; and a core portfolio of high-quality bonds.
With those essentials taken care of, let's move on to six potential sources for increased income. These are more aggressive investments for more adventurous income investors.
The bond side
The type of investment you choose when seeking increased income depends not only on the extent of the risk but also on the kind of risk you're more comfortable with. High-yield bonds, international government bonds, and preferred securities all involve different types of risk.
High-yield bonds. These are bonds with higher credit risk, meaning they have a higher risk of default. High-yield bonds also generally have greater correlations with stocks than other types of bonds—meaning that when stocks fall, high-yield bonds will often fall, too.
International government bonds. Bonds outside the United States present a unique set of political, cultural, and economic considerations collectively referred to as sovereign risk. In addition to that, international bonds present some currency risk—meaning that the comparative strength of the local currency to the US dollar may affect the value of your investment.
Preferred securities. These hybrid investments combine the attributes of stocks and bonds, and gained notoriety as one of the hardest-hit investments in the 2008 credit crisis. While preferred securities are often compared to high-yield bonds, one of many important distinctions is that investment-grade companies can offer preferred shares—so you may be able to find higher credit quality here.
The stock side
Let's remember that stocks and bonds play very different roles in your portfolio, and that dividend-paying stocks are not necessarily an appropriate substitute for (income-generating) bonds. With that caveat, if you're interested in generating income from stocks, you can try dividend-oriented stock funds, such as large-cap value funds that focus on blue-chip dividend-paying stocks with some potential for growth. Other options include:
Real estate investment trusts (REITs). The first place many people look for stock income beyond blue-chips is real estate, often in the form of REITs, which have to distribute 90% of their income to shareholders as dividends in order to avoid corporate taxes. Generally, we suggest that you treat REITs as small-cap stocks when you're planning your strategic asset allocation.
International dividend-paying stocks. Foreign companies, particularly in Europe, often pay out a higher percentage of their profits in dividends than US companies. The dividend yield on the S&P 500® recently crept up to 2%, while the dividend yield on a broad index of stocks tops 2% in Germany and Japan and is over 4% currently in France and the United Kingdom.1 International investments, of course, involve their own risks, as mentioned earlier.
Master-limited partnerships (MLPs). Master-limited partnerships are a niche sector in the income world, composed primarily of oil and gas partnerships that pay a regular dividend stream. Those who invest in this sector generally have specialized experience, and the resources available to analyze MLPs closely are, unfortunately, limited. Unless you follow these securities closely, we suggest approaching these cautiously.
- Source: MSCI France, MSCI Germany, MSCI Japan and MSCI United Kingdom equity indexes.
For mutual funds and exchange traded funds investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost.
Past performance is no guarantee of future results.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. High-yield bond funds invest in lower rated securities and are subject to greater credit risk, default risk, and liquidity risk.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets.
Investing in REITS may pose additional risks such as real estate industry risk, interest rate risk and liquidity risk.
Sector funds are typically not diversified and focus their investments on companies involved in a specific sector, the funds may involve a greater degree of risk than an investment in other funds with greater diversification.
Investing in dividend stocks carries some risk—the same as with any other type of stock investment. With dividend stocks, you can lose money; for example, share prices can drop (regardless of whether the company pays dividends), companies can reduce or eliminate dividend payments at any time and inflation can reduce savings. Stocks or stock funds generally have a higher degree of risk to capital than bonds or bond funds.
Certificates of deposit may have fixed or variable rates and are Federal Deposit Insurance Corporation (FDIC)–insured. Penalty for early withdrawal may apply.
Diversification strategies do not assure a profit and do not protect against losses in declining markets.
The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Examples provided are for illustrative purposes only and are not intended to be reflective of results you can expect to achieve.
The MSCI France, MSCI Germany, MSCI Japan and MSCI United Kingdom equity indexes are constructed by identifying every listed security in each country's market. Securities are free float adjusted, classified in accordance with the Global Industry Classification Standard (GICS®), and screened by size, liquidity and minimum free float.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.