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By Aaron Levitt
| March 16, 2017
While utility stocks have taken it on the chin lately with the Federal Reserve starting to raise rates, the reality is, they still make sense for retirement investors.
Utility stocks are often a go-to asset class for those in retirement, as the sector provides plenty of big income opportunities. After all, consumers, businesses and municipalities still need to power their operations and cool their homes, even in tough economic times. Water still needs to flow, and electricity hums through power lines. Ultimately, utilities’ stable cash flows and recession-resistant nature make them ideal candidates for investing during retirement.
But here’s the real kicker for utility stocks.
The Fed is raising rates, and that has caused them to flounder. But the sector has historically realized faster dividend growth than the pace of interest rate increases and inflation. For retirement investors still looking for stability of income, utility stocks could offer a unique value today — especially when you factor in the potential for higher income later on.
With that in mind, here are three ways to play utility stocks — one stock, one ETF and one mutual fund.
Prices and data are from the original InvestorPlace story published on March 14, 2017. Click on ticker-symbol links in each slide for current prices and more.
Dividend yield: 3.6%
When it comes to buying individual utility stocks, retirement investors are looking for one thing — stability of income. Megautility American Electric Power Company Inc. (AEP) has that in spades.
AEP is one of the largest electric utilities in the United States. Its system features more than 26,000 megawatts worth of generating capacity as well as the nation’s largest electricity transmission system. It has more 765-kilovolt extra-high voltage transmission lines than the rest of the U.S.’s transmission systems put together. This vast system and the cash flows from its nearly 5.4 million customers in 11 states has allowed AEP to pay a solid dividend since its founding in 1910.
Stability aside, AEP does have some opportunities for growth in the next few years as well. The regulatory environment has thrown it a major bone.
First, the firm is pretty coal-heavy regarding its generating capacity. With the Donald Trump administration throwing water on the Clean Energy Plan, AEP should still have some time to change over capacity. Meanwhile, regulators in its central operating area of Ohio have been pretty favorable with rate hikes lately. All of this should help strengthen AEP’s 3.6% dividend in upcoming years.
For retirement investors, you certainly couldn’t do much better than AEP as a cornerstone for your portfolio.
Dividend yield: 3.1%
When it comes to buying utility stocks via broad indexed exchange-traded funds, the Utilities SPDR ETF (XLU) often gets the nod. There’s nothing wrong with the XLU — it features plenty of liquidity and dividends. But retirement investors can do better. And that better choice is the Vanguard Utilities ETF (VPU).
For starters, VPU offers broader coverage to utility stocks in the U.S. and includes large-, mid- and small-cap firms. That wide-sweeping approach bumps its total number of holding to 75 — roughly triple what the XLU holds. That addition of small- and mid-cap utilities is vital, as it allows VPU to profit from some of the “growthier” names in the sleepy sector. But remember, these are still utilities, and stable cash flows are still the name of the name.
The addition of that growth has allowed VPU to return an average of 7.1% over the last ten years. That bests the large-cap only XLU which returned about 6.9% annually. That may not seem like much, but it’s enough compounded over time to mean some serious moola.
VPU also beats the XLU on another metric — expenses. As a Vanguard fund, VPU features a rock-bottom expense ratio of 0.1%. The XLU clocks in at 0.14%.
In the end, when it comes to utility stocks, VPU is the best ETF choice.
Dividend yield: 2.8%
For those retirement investors looking to be a bit more active with their utility investments, the American Century Utilities Fund (BULIX) mutual fund could be an excellent choice.
BULIX is constructed using American Century’s process of systematic risk management. The idea is to find the optimal tradeoff between risk and total returns. So far that has worked wonders for the mutual fund, as its managed to return 8.36% annually since its inception in 1993 and features a four-star Morningstar rating.
In addition to its process, part of the reason for the fund’s outperformance comes down to its benchmark — the Russell 3000 Utilities Index. The Russell index also includes telecommunication firms and wireless/broadband providers in the “utility stocks” category. Both AT&T Inc. (T) and Verizon Communications Inc. (VZ) have been huge winners over the last decade or so, as wireless adoption has taken hold. They just so happen to be BULIX’s top two holdings.
Either way, the fund has delivered on the returns front.
BULIX delivers on the income side of the equation as well. The fund currently yields a healthy 2.8%. Expenses clock in at 0.68%.
This article is by Aaron Levitt of InvestorPlace. As of this writing, he held none of the aforementioned securities.
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