Consumers often think about income from their investments in two main contexts: withdrawals for short-term priorities, including emergencies, and portfolio income for long-term objectives, such as retirement. Distribution needs that fall within a five-year period, such as automobile repairs or a down payment on a new home, are generally characterized as short-term priorities. Income needs that stretch beyond the next five years are considered long-term priorities.
Keen investors are painfully aware that the Federal Reserve’s aggressive rate hikes since March of last year have changed the income landscape for market participants. And while the Federal Reserve’s march to curb inflation appears to be working — the Bureau of Labor’s personal consumption expenditures price index has dropped from a 9.1% annual rate in June of 2022 to 3.7% this August — investors still want to be compensated for their patience and to prepare well for any policy shifts in the future.
For the first time since before the Great Recession, we have now attractive yields on a variety of income-oriented investments. Here are seven income strategies to consider for your own planning purposes:
— Cash deposits.
— Preferred stocks.
— Dividend-paying stocks.
— Real-estate investment trusts (REITS).
— Multi-asset income investments.
More than 6 in 10 consumers already live paycheck to paycheck, and 80% say their wages have not kept up with the pace of inflation, according to a 2023 New Reality Check: The Paycheck-to-Paycheck Report,
conducted by PYMNTS and the LendingClub. If a $1,000 emergency arose, would it disrupt your ability to stay afloat with your monthly spending needs? One rule of thumb is to set aside three to six months’ worth of fixed expenses in cash reserves at a bank or credit union. One effective strategy to build an emergency savings account is to automate your cash flow through fixed, monthly deposits with your financial institution on your own or through savings apps, such as Chime or Qapital. Currently, some banks and credit unions are offering consumers between 3.1% to 5.2% annual percentage yield, or APY, for their savings deposits, according to September 2023 data from Bankrate.
It’s no secret that bonds had a rough ride in 2022. The Morningstar U.S. Core Bond Index, which covers an array of government and investment-grade corporate bond markets, lost 12.9% last year — the index’s largest annual loss since it began tracking fixed income back in 1999. Most of the negative performance among bonds last year was linked to the Federal Reserve’s steep rate hikes.
At some point — possibly as early as this year — the Federal Reserve will pause on any further rate hikes, and the headwinds for bonds will abate. In fact, the Federal Reserve Board of St. Louis’ published projections indicate that the median federal funds rate may dip to 4.6% in 2024 and fall even further to 3.4% in 2025.
As such, many institutional analysts and portfolio managers have already revised their outlooks for bonds for the coming decade.
“Risks in investment-grade markets are already mitigated to some degree as a result. With that said, bond total returns — price change plus interest income — will be mostly determined by inflation rates and interest rate markets. The post-pandemic environment taught us how difficult it is to predict short-term changes in both, so we have to set expectations based on longer-term themes,” suggests Scott Knapp, chief market strategist at TruStage.
PGIM recently published its 10-year outlook for U.S. investment grade bonds (4.84%), U.S. high-yield bonds (5.41%) and global bonds (4.22%). Fidelity’s 20-year outlook is also sanguine for U.S aggregate bonds (4.8%), U.S. high-yield bonds (6.4%), developed ex-U.S. bonds (5%) and municipal bonds (4.5%).
Preferred stocks offer investors hybrid qualities often associated with bonds and stocks. Like bonds, preferred stocks typically offer investors scheduled income payouts and par values. Preferred stocks are technically equities, so they carry higher risks than bonds, but less risks than common stocks because they are “preferred” (or ranked ahead of) common stocks in dividend payouts and in the event of any corporate liquidations. Like common stocks, many preferred stocks pay “qualified dividends,” which means the dividend income is subject to lower tax rates than interest income from other sources, like bonds.
Qualified dividends are typically taxed at zero, 15%, or 20% rates, depending on a person’s income limits. These lower taxable rates can be a potential advantage for high-income earners. For example, since 2010, preferred stocks have provided high-income earners — those subject to the 37% marginal tax rate — an average after-tax return of 4.9%, compared to 3.6% from municipal bonds and 3% from investment-grade bonds, according to data from Bloomberg and Charles Schwab.
Dividend-paying stocks carry a higher investment risk than bonds; however, unlike bonds with fixed coupon payments, companies that consistently increase their dividends can help shareholders keep up with inflation and protect their purchasing power over time. Look for companies that have dividend payout ratios between 40% to 50%, which means they retain adequate earnings to spur growth and retain margins of safety for challenging times. Of course, the biggest allure of dividend stocks is that they also have the potential for meaningful capital appreciation.
Real-Estate Investment Trusts (REITS)
Real-estate investment trusts own, operate or finance real estate in some fashion. REITs typically include offices, apartment buildings, warehouses, retail centers, medical facilities, storage facilities, data centers, cell towers, infrastructure or hotels in their holdings. The National Association of Real Estate Investments (Nareit) estimates U.S. public REITS own roughly $2.5 trillion in assets across 535,000 properties and 15 million acres of timberland across the U.S.
REITs generally pay out at least 90% of their taxable income to investors (most pay out 100%), and their income yields are often higher than bonds. About 150 million American households own REITs through their employer-sponsored plans, IRAs, pension plans, and other investment funds, according to data from Nareit.
Multi-Asset Income Investments
Multi-asset income mutual funds and exchange-traded funds, or ETFs, typically offer investors a diversified allocation of stocks, bonds and other types of income-oriented securities like bank loans, covered calls and currency hedges. Investors who prefer a growth-and-income strategy (the proverbial 60/40 portfolio) sometimes incorporate a multi-asset income fund to broaden their income capacity and bolster their downside protection.
Julia Hermann, multi-asset portfolio strategist for New York Life Investments Investors, suggests a dynamic approach for income in the coming years. She comments, “Investors can pursue income-preservation goals not just with yield, but also with exposure to asset classes that traditionally benefit from inflationary periods. Global infrastructure bonds and equities both have inflation-hedging potential.”
According to a new survey released by Greenwald Research, 88% of workplace plan participants want retirement income that can keep up with inflation, and 86% want a guaranteed, lifetime income stream to cover their basic living expenses. One income strategy that is picking up steam among plan sponsors and financial planners is the use of low-cost, straightforward annuities to provide consumers with the “pension-like” outcomes they’ve requested. Blake Phillips, regional vice president for DPL Financial Partners, suggests that “commission-free advisory annuities have gained in popularity as investors seek sources of protected income for retirement. With pensions disappearing and market volatility unsettling many investors, annuities can be a great way to complement a total return portfolio with a secure income stream.”
While the advent of high inflation, followed by aggressive policy shifts from the Fed, have caused investors to second-guess whether some of these strategies for current income — especially bonds — still make sense for their portfolios, the reality is each strategy can potentially play a vital role in investors’ long-term financial plan. Market conditions like inflation, economic slowdowns and policies can change on a dime, but the benefits of diversified investment strategies stand the test of time.
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Update 09/21/23: This story was previously published at an earlier date and has a been updated with new information.