As if we didn’t have enough economic trouble, unemployment has hit its highest rate since the Great Depression, small businesses are hanging on for dear life, and real (after inflation) interest rates are negative. This creates serious problems for savers and retirees who are relying on investment and savings income to live.
At these historically low rates, inflation is eroding the value of our savings, adding to the fact we are unable to achieve a reasonable level of income.
So, where to look for higher yields without taking on unintended risk?
Resist the siren song of the highest yielding stocks. Beware the elevated yields of this cohort which often reflect investor concern. The worry may center around potential insolvency, deteriorating business conditions or an impaired business model that defies turnaround.
The sustainability of the dividend is also often suspect (recent dividend cuts and eliminations are at recent highs) and the potential for capital appreciation, slim. If the dividend is safe you should ask why management and the board of directors are willing to pay such a high premium? Subpar earnings and growth prospects would be a good place to start.
Take a look a these high yielding stocks: Exxon Mobil yields 7.8%; Simon Property Group yields 15.4%; Dow, Inc. yields 7.8% and The Gap yields 11.8%.
You tell me. Are those dividend yields sustainable? And are these companies you want to own? The yields are telling you the risk is high.
There may be better sources of income.
Convertible bonds share many of the same characteristics of corporate bonds with one exception. If you own them, you have the option to convert your holdings into a predetermined number of shares of the company’s common stock. Because of this, the underlying bond participates in some in the upside appreciation of the common stock and retains a degree of downside protection due to the bond floor (the value of the bond without the conversion option of the equity). With the 30-year Treasury bond yielding under 1.4% and the yield on the S&P 500 at 2.05%, convertible securities can provide a viable income option.
Convertible preferred securities are often combined with convertible bonds to enhance yield. They also enhance volatility because the securities are more sensitive to the movement in the common stock. Together, however, they provide an interesting source of income with an equity price performance kicker.
I reviewed a number of convertible bond/preferred stock ETFs (exchange-traded funds) and found the funds generally provided a yield greater than 5% and year-to-date returns better than the S&P 500.
Covered calls are a little trickier but can also provide enhanced income. Writing a covered call is a contract selling the right to purchase a stock you own at a specific price and a pre-determined time frame. The primary benefit is the additional income generated by the call premiums. While you can implement the strategy in your own portfolio, it requires vigilant management. Again, there an abundance of ETFs and mutual funds to choose from.
Each of these strategies comes with unique risks and rewards and should represent only a portion of your overall allocation if in line with your risk and reward objectives.
Do your research. And as always, remember, diversification is paramount.