To the dismay of yield-seeking investors, interest rates remain at historic lows. Although rates on long-term bonds may begin to inch up, analysts generally expect that we may remain in a low-interest-rate environment for a while longer. So, what are income investors to do? It is important to understand the risks of reaching for higher yields and realize there may be less risky ways to increase income.
IT’S ALL ABOUT THE RISK-REWARD RELATIONSHIP
When investing for any purpose, returns always boil down to the risk-reward relationship. The laws of investing dictate that it is very difficult to increase your return without also increasing your risk. While you can increase your yield by investing in lower-grade or longer-term bonds, you also increase your risk should interest rates suddenly rise.To learn more about how bonds react to interest rates, watch this short video.
Income investors, especially retirees, want to generate cash. However, they also need to preserve their capital.By focusing on yield without regard to capital preservation, you increase your overall risk. In a low-interest-rate environment, the better strategy is to broaden your sources of income through total returns.
FORGET ABOUT YIELDS – LOOK TO TOTAL RETURNS
“Total returns” is a strategy that invests in a combination of income and appreciation investments that, when allocated among different asset classes, can increase income while minimizing portfolio volatility. The goal is to generate sufficient current income while growing enough capital to keep up with inflation. A well-diversified portfolio of high-quality dividend stocks and investment-grade bonds can generate higher risk-adjusted returns more safely than a portfolio of the highest yielding, below investment-grade bonds.
Income investors do not have to suffer through an extended low-interest-rate environment. However, it does require a strategic approach tied directly to your specific risk-return profile. Working with a well-qualified investment advisor, just about any risk-return profile can be matched with a balanced and diversified total return portfolio strategy.
