A Case for High-Yield Investments
The data I have seen indicates that if you don’t need to draw down your investment for twenty years or more, you may do well to put it all in stock funds and just leave it alone. For reasons discussed here the average investor will likely do better to buy an index fund like the S&P 500 rather than trying to pick individual stocks. The long term average return (including reinvested dividends) in the U.S. stock market has been about 10 % before adjusting for the effects of inflation. (All my remarks here pertain to U.S. investments; hopefully some aspects may be applicable to other countries).
However, particularly as you age, financial advisors typically counsel investors to allocate some portion of their portfolio to more-stable fixed-income securities that generate cash to spend and keep you from having to sell stocks during a market downturn. Historically, long-term investment grade bonds have been used to provide steady cash, and to serve as an asset which often went up if stock went down. Thus, a 60/40 stock/bond portfolio was considered prudent. That model has been less useful in recent years, since bond yields have been so low, and since long-term bonds sometimes fall along with stocks, e.g. if long-term interest rates rise.
Another driver now for allocating some savings into non-stock investments is that after the large run-up in stocks last few years, which has far exceeded gains in actual earnings, the market may well muddle along flatter in the coming decade. In regular stock investing, you are banking primarily on stock price appreciation – you are counting on someone else paying you (much) more for your shares some years hence than you paid for them. But what if the “greater fools” don’t materialize to buy your shares?
Also, the inflation genie has been let out of the bottle, and it may be tough to get inflation back under say 4%; investment grade bonds are yielding appreciably less than inflation these days, so you are losing money to buy regular bonds.
Finally, if your stock is cranking out say 8% cash dividends, and you are holding it for those dividends rather than for price appreciation, when the market crashes (and this particular stock goes down in price, along with everything), you can be blithe and unruffled. In fact, you can be mildly pleased if the price goes down since, if you are reinvesting the dividends, you can now buy more shares at the lower price. Trust me, this psychological benefit is important.
Some High Yielding Alternative Investments
In this blog over the coming weeks/months we will identify several classes of securities which generate stock-like returns (around 7-10 % returns, if the dividends are continually reinvested) via dividend distributions rather than through share price appreciation. These securities often have short-term volatility similar to stocks, so they should be treated in the portfolio as partly as stock-substitutes rather than as substitutes for stable high-quality bonds. However, the better classes of high yield investments maintain their share prices over a long (e.g. 5-year) period, similar to bonds, but with much higher yields.
We will discuss High-yield (“junk”) bonds , senior bank loans, preferred stocks, Real Estate Investment Trusts (REITs), Business Development Companies, Master Limited Partnerships, and selling options (put/calls) on stocks.
I’ll close today with three examples of these high yield securities, which I have happily held for many years. They yield 8-9%, and their share prices have held relatively steady over the past five years:
Cohen&Steers Total Return Realty Fund (RFI). Current yield: 8.0 %
Ares Capital (ARCC) Current yield: 8.1%
Eaton Vance Tax-Managed Buy-Write Opportunities Fund (ETV). Current yield: 8.8%
(Charts from Seeking Alpha)