In case your retired clients haven’t reminded you lately, it’s a tough environment for investors seeking portfolio income. According to the “Wall Street Journal,” in late July, money market funds paid an average 0.40 percent. Five-year certificates of deposit (CDs) averaged 1.39 percent nationally, 10-year Treasuries had yields of around 2.5 percent and the trailing 12-month dividend yield on the S&P 500 was 1.91 percent.
It’s been a while since retirees could count on generous earnings from their portfolios, and given the Federal Reserve’s policies, it could be years before we see significantly higher yields. Here are a few strategies to help advisors and investors cope in this tough environment.
Up the ladder
Bond ladders are a tried-and-true approach to managing clients’ bond portfolios. Russ Francis, CPA, CFP with Portland Fixed Income Specialists, LLC in Beaverton, Ore., continues to build muni bond ladders for higher-net-worth clients who want steady income. He generally keeps the maximum maturity to 12 years or less and sticks with investment grade bonds.
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Bond ladders provide several benefits, Francis maintains. They help mitigate interest rate risk from falling and rising rates. If clients don’t need the principal from a maturing bond, then they can reinvest in the ladder. It’s also a low-cost solution, because there are no ongoing investment fees for holding bonds, apart from Francis’s quarterly portfolio management fees.
A modified barbell
A barbell strategy splits the client’s bond investments between very short- and longer-term bonds. Andrew Feldman, CFP, with AJ Feldman Financial in Chicago, Ill., has developed a modified barbell for some of his clients. He divides the clients’ fixed income holdings between “ultra-safe” investments (CDs, money market funds and cash) and more aggressive investments, such as high yield and closed-end funds. That approach allows him to create a fixed income portfolio with less risk than one allocated to all higher yield investments while generating a more competitive yield, he explains.
Safety plus potential
Any time you shift clients’ assets away from short-term or guaranteed accounts, you change their portfolio’s risk and most likely increase the odds of losing principal. Mo Vidwans, CFP, with Vidwans Financial LLC in Saline, Mich., has balanced the safety versus return question for some of his clients with bank-issued structured CDs. These accounts are FDIC-insured and are sold with a low minimum guaranteed return and a higher potential return tied to a basket of traded stocks. Each CD’s structure is different, but in general, if the stocks perform well, the investor earns a higher interest rate than the minimum up to some specified cap. Vidwans has two clients in structured CDs currently and says that this year they have earned 5.75 percent interest on their accounts.
A focused search for dividends
There’s a strong case for including dividend stocks in a retirement portfolio. Dividend stocks can be competitive: Many top U.S. companies have dividend yields of 3 percent and higher. Dividend-paying companies often increase their payouts regularly, providing shareholders with a growing income that can keep pace with inflation. Finally, these stocks have the potential for a higher total return from the combined dividends and share price increases.
Of course, dividends and share prices aren’t guaranteed. When companies cut or suspend their dividends, their share prices often get hammered—just ask bank stock investors who suffered through the 2008-2009 financial crisis. There’s also the question of valuation. Investors have been bidding up dividend stocks for several years, which could mean less potential share price appreciation over the near-term.
These potential drawbacks highlight the need for careful dividend stock selection. Christian G. Koch, CFP, CPWA, with KAM South LLC in Atlanta, Ga., believes regional bank stocks can avoid some of these problems. Dividend yields in the sector are in the range of 3 percent to 4 percent, and stock prices are near book value, he explains. Also, this sector tends to do well as interest rates rise in contrast to some other financial institutions.