Portfolio Discussions: Diversified sources of income
With interest rates still near historic lows and traditional fixed income failing to meet investors’ income needs, diversifying across asset classes and around the world has never been more important.
Traditional “safe” sources of income are yielding a fraction of what they once did
- The Federal Reserve has hiked rates six times this cycle, continuing what will be a long normalization process. While interest rates will remain low by historical standards for some time, they are gradually headed higher.
- In 2006, the annual income from a $100,000 6-month CD was roughly $5,000. Today, it is a fraction of that, with yields below the rate of inflation failing to generate positive real returns.
Rates on core fixed income remain near all-time lows
- The yield on the 10-year U.S. Treasury remains low, but should continue to rise as the Fed normalizes monetary policy and the U.S. economic expansion continues. Looser fiscal policy also has the potential to push interest rates higher.
- The combination of interest rate risk and already low yields suggests investors should diversify their fixed income investments and look beyond core bonds for income.
Broadening the search for yield: Diversify across asset classes and around the world
- Dividends can be another important source of income. In fact, dividends have accounted for nearly half of the stock market’s historical total returns, while at the same time helping to reduce overall portfolio volatility.
- Investors may want to look abroad for income, as dividend yields on foreign stocks are often higher than those in the United States.
- Investors can generate income from foreign bonds, as well as other types of investments, such as REITs, convertible bonds and preferred stock. This allows them to further diversify their portfolios while simultaneously addressing their income needs.
- Cash and traditional sources of income currently provide historically low yields.
- With interest rates historically low, an undiversified approach to fixed income is fraught with a number of risks.
- To generate income, investors should consider broadening their exposure to bonds, as well as other income-producing assets such as REITs and dividend-paying stocks, both in the U.S. and abroad.
Focusing on different asset classes or regions, Portfolio Discussions help to frame investment conversations using slides from the Guide to the Markets.
There is no guarantee that companies that can issue dividends will declare, continue to pay or increase dividends.
International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations.
Diversification does not guarantee investment returns and does not eliminate the risk of loss. Diversification among investment options and asset classes may help to reduce overall volatility.