by Jana Swenson
At its most recent meeting, the Federal Reserve’s Federal Open Market Committee made the decision to keep the target range for the federal funds rate – the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight – at 0 to ¼ percent. It’s likely that this rate will remain low for the foreseeable future.
While this may be great news for borrowers, it can create a challenge for those investors looking for income. The current low interest rate environment has resulted in paltry yields for income investors, many of whom have begun exploring other options for income.
One popular option is dividend-paying stocks. High-quality companies with a proven track record of profitability often pay dividends to investors that can be significant. Dividend-issuing stocks typically offer less volatility than do growth stocks, because the dividends they pay are based on the company’s profitability, not market perceptions. However, it should be noted that changes in market conditions or a company’s financial condition may impact the company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments. In addition, stocks are subject to risk, including possible loss of principal.
But while dividend-paying stocks may appear to be an attractive alternative to bonds, it’s worth noting that in February, the Dow Jones Industrial Average hit a five-year high. Will income investors who choose dividend-paying stocks over bonds be buying into an over-priced market?
When looking for income, many investors will look at traditional investments such as bonds, which may be taxable or tax-free. Unlike stocks, bonds do not give the holder an ownership interest, as they are simply a lending tool used by an entity – typically a government, municipality, corporation, or federal agency – to raise money. Typically, the higher an issuer’s credit rating – as measured by independent credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch Ratings – the lower the interest rates on its bonds, as well as the lower the risk of default. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall.
So, where are interest rates going to from here? With interest rates at historically low levels, will bond investors be prepared for potential volatility in bond values when rates do go up?
These are certainly complicated times for anyone looking to generate income from their portfolio. To learn more about the various investment strategies for income available to you, and to learn which ones may best suit your unique financial needs, contact your financial professional today.
Jana Swenson is a Vice President/Investments with Stifel, Nicolaus & Company, Incorporated, member SIPC and New York Stock Exchange, and can be reached by calling the firm’s Murrieta, California office at (951) 461-7220 or toll-free at (866) 894-2461.