There are other sources of yield besides dividend stocks.
Do dividend stocks belong in your retirement portfolio? If you’re investing for income, the answer is likely yes. “Income investors like dividend stocks because they’re typically less volatile,” says Joyce Choi, iShares fixed income product strategist at BlackRock. Along with a potentially stable stream of income, dividend stocks have the added benefit of inflation protection “because companies have the ability to increase their dividend over time,” says Matthew Peck, certified financial planner and co-founder of SHP Financial. But those increases aren’t guaranteed. General Electric Co.’s (GE) decision to slash its dividend payout 50 percent in November 2017 is proof that dividend payouts can evaporate. Fortunately, yield-seeking investors have the following income-producing alternatives.
Real estate investment trusts
Historically, REITs have offered access to a profitable asset class, with built-in inflation protection. Their main draw compared to dividend stocks is the higher yield, says Matthew Essmann, managing partner of Cornerstone Financial Services. He says if you have a specific income level you’re aiming for, REITs may tip the balance to where your portfolio’s average yield needs to be. The lack of correlation between REITs and stocks is another advantage. “A REIT will generally hold many different properties so you’re spreading the risk around,” Peck says. Just make sure you’re diversified. REITs with similar holdings could all suffer if the sector those REITs target slumps.
Closed-end funds
Though less common than mutual funds or exchange-traded funds, “closed-end funds are attractive alternatives for income investors, particularly for low-liquidity investments such as bonds or loans,” says Jay Hatfield, portfolio manager of InfraCap MLP ETF (AMZA) and InfraCap REIT Preferred ETF (PFFR). Because closed-end funds have a fixed number of shares and are bought and sold only in the market, they can sell at a discount to the underlying net asset value, which is a mutual fund’s assets minus its liabilities, divided by the number of shares outstanding. The primary risk is that the funds’ fluctuating values can differ significantly from NAV, making an investor’s timing of trades critical, Hatfield says.
Bonds
If you’re worried dividend stocks will fall in a market downturn, bonds could be the portfolio stabilizer you need. “Bonds generally offer higher yields and lower volatility than equity income alternatives,” Hatfield says. Though higher interest rates can depress some bond prices in the short run, “in the longer term, bonds that don’t default will mature at par value, and the prevailing level of yields will be higher,” says Phil McDonald, director of investments at Symmetry Partners. Your choice of bond can reduce the biggest risk — interest rates. “Floating rate bonds or short-term duration bonds are what investors should be diversifying with [now], beyond dividend stocks,” Essmann says.
Master limited partnerships
A potential source for attractive yields, MLPs are slightly more complex than most income options. The Alerian MLP Index, the leading gauge of energy MLPs, currently yields 8.17 percent, compared to 1.91 percent for the Standard & Poor’s 500 index. Hatfield says energy midstream MLPs deserve special attention, “as they offer yields of almost 9 percent, with growth prospects improving as oil prices rise with the global economy.” The energy sector exposure that characterizes MLPs can increase concentration risk, McDonald says. If energy stocks fall, energy MLPs can fall, too. Plus, there may be limits on the amount of MLP distributions a tax-managed account can accept.
Preferred stock
The primary benefit of preferred stock versus common stock is their preferential treatment. Preferred shares have a fixed dividend that must be paid out before any dividends are paid to common shareholders. Essmann says preferred stocks have a place alongside common stocks and other income-producing investments in a diversified portfolio. Like MLPs, however, there’s the potential for concentration risk. “Preferred stocks tend to overwhelmingly be issued by financial firms,” McDonald says. Hatfield says the risk that preferred shares will be called in is another downside. “Investors should seek out preferred ETFs that have rules that limit call risk and optimize returns.”
Income funds
This variation of mutual funds and ETFs prioritizes current income rather than capital appreciation. These funds can include bonds, common stocks, preferred dividend stocks and money market instruments. Some income funds may also include a select number of growth stocks, but beware of cost. “At times, the expenses of the funds eat into your income,” Peck says. He also advises choosing an actively managed income fund to curb interest rate risk. But avoid income funds that invest exclusively in dividend stocks as that limits your diversification, McDonald says.
Dividend ETFs
These ETFs are diversification simplified. “The main advantage of dividend ETFs over dividend stocks is broad market exposure,” Choi says. You don’t run the risk of your dividend being reduced or eliminated the way you would if you were investing in a single company, and dividend ETFs are a great way “to seek income and gain access to companies that have a history of sustained dividend growth.” Because dividend ETFs trade closely to NAV, they don’t have the premium or discount risk of other ETFS, Hatfield says. The major drawback? “The ETF will often have a lower yield than desired because of lower-yielding stocks within the index the ETF is based on,” Essmann says.
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7 Dividend Stock Alternatives to Fuel Retirement Income originally appeared on usnews.com
