Over the past few years — since the financial crisis of 2008 — we’ve seen interest rates compress to historic lows.
That’s been good for people with debt and those who are borrowing to buy a car or a home. But it’s problematic for careful savers and retirees looking to pull income from their investment portfolios.
A Risky Migration for Many
They paid off their mortgage, dumped their debt and put their money into safe financial vehicles, like certificates of deposit and money market accounts — only to see their nest eggs slowly crumble, thanks to inflation.
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As a result, many ended up leaving the secure savings vehicles they loved to reach for higher yields in riskier asset classes, perhaps without understanding what it could mean in the long run.
Bonds Get Bumpy
Now, as we enter what appears to be a rising-interest-rate environment (central bank policymakers have raised rates three times since December and are forecast to lift them a quarter of a percentage point once more in 2017), it could mean trouble for those who bought into funds with high-yield longer maturities.
A rise in rates can make things pretty bumpy for bond assets. We actually saw that happen rather aggressively right after the presidential election.
If that made you a bit nervous (and if it didn’t, it should have), it may be time to do a little portfolio rebalancing.
What Should Bond Investors Do?
Super-safe investors who want to stay with their bonds should look at repositioning into shorter-term (three- to five-year) bonds, which are traditionally less sensitive to rising rates than intermediate- and long-term bonds.
Floating rate notes, which typically have a two- to five-year term to maturity, also tend to behave better in a rising-interest-rate environment. FRNs have variable rates that reset periodically.
Senior Loans and Dividend Options
Another option is to pivot more into senior loans, which are loans banks make to corporations and then package and sell to investors. They’re usually secured by collateral, and if the company fails, investors are the first to be repaid — so these investments are considered less risky than high-yield bonds (although they are not risk-free).
Investors who can stomach a little more volatility may wish to move to Dividend Aristocrats, a select group of S&P 500 stocks with strong balance sheets and 25-plus years of consecutive dividend increases. These dividend growth stocks have performed well over the long term.
The Bottom Line
Now is not the time to be complacent with your income strategy.
As we enter a new era of rising rates, don’t fall victim to chasing yield and buying the biggest dividend payers. This can be an indicator of internal problems on a company’s balance sheet. The reality is, that dividend may not be around forever.
A wiser overall plan may be to invest for total return. Remember: This money is meant to last a lifetime. Yes, you want some growth to stay ahead of inflation, but you don’t want to put your retirement income at risk.
Don’t let your fears or confusion about what to do next overwhelm or paralyze you. A trusted financial professional can help you rework your strategy into something that can lower your risk tolerance while maintaining as much growth as possible.
Kim Franke-Folstad contributed to this article.
This article was written to give broad-based recommendations and ideas. Clients should discuss any proposed strategy mentioned in this newsletter with Dan & Jason to see how it aligns with your portfolio, risk & personal circumstance.
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