Yield-seeking investors rely on income-producing investments to mitigate the volatility of stocks. That’s particularly true of investors approaching or already in retirement.
Higher yields boost returns from assets, such as bonds or dividend-paying stocks. That means you can dial down your total portfolio allocation to stocks, which return more than fixed-income investments but are also more volatile.
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While the timing of future Federal Reserve rate cuts remains a big question mark, it’s not too soon to plan ways of locking in yield for the long term.
That means turning to investments other than equity. While some dividend stocks can deliver higher-than-average yields, those yields fluctuate with share price.
Here are some ways you can lock in yield ahead of any rate cut, without worrying about fluctuations that could affect your retirement planning:
— Bonds
— Multiyear guaranteed annuities
— Preferred stock
— Defined-maturity ETFs
— Certificates of deposit (CDs)
Bonds
The most common way to lock in yield for the long term is by investing in bonds, but it’s important to understand how to make bond maturities work in your favor.
Allison Walsh, senior vice president, investment product strategist and head of ESG and corporate sustainability at Income Research + Management in Boston, says bonds offer a compelling value proposition for investors at current yield levels, which are the highest in more than 15 years.
“While not a certainty, the Federal Reserve has communicated that interest rate hikes have very likely been completed,” she says.
“While Treasurys generally do look attractive in today’s market, we also see good opportunities in the corporate and securitized markets,” Walsh says. “A mix of high-quality sectors in a fixed-income portfolio allows for diversification and a higher yield than would be available in a Treasury-only portfolio.”
Bond maturities affect yield significantly. Generally, longer-term bonds offer higher yields to compensate for the increased risk investors are taking. After all, it’s anyone’s guess where interest rates and inflation will be 20 or 30 years from now. Investors want to be compensated more for taking on that uncertainty when they buy a long-term bond. On the flip side, short-term bonds typically have lower yields because investors have more visibility into where rates may be in one to three years.
The relationship between long- and short-term yields doesn’t always hold true, however. Longer-term yields are currently lower than short-term yields, a reflection of investors’ expectations that interest rates will decline.
Multiyear Guaranteed Annuities
A multiyear guaranteed annuity is a type of fixed annuity that offers a guaranteed interest rate for a specified period, typically ranging from three to 10 years. These annuities can offer stable, predictable income, but they have some potential drawbacks.
“Annuities can be complex financial instruments,” said Roger Silk, CEO of Sterling Foundation Management in Reston, Virginia. “Many annuities appear to pay high annual interest rates, but in some cases that is because each annuity payment constitutes partly a return of capital.” He added, “Annuities are generally more appropriate as insurance against outliving your money than they are as pure interest rate investments.”
In addition, because annuity owners get a return in exchange for keeping their money locked up for a set period, it’s costly to surrender the contract early if the account owner needs fast cash.
Investors interested in a multiyear guaranteed annuity should be sure to understand exactly what they are purchasing. “Find reputable insurance companies who offer competitive rates and also assure that the annuity aligns with personal financial goals,” says Taylor Kovar, CEO of Kovar Wealth Management in Lufkin, Texas.
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Preferred Stock
Preferred stock is a form of equity ownership that pays fixed dividends. Owners of preferred shares receive their payments before common shareholders, should the company become distressed. These shares typically lack voting rights, but that’s the tradeoff for the higher income stability.
“Preferred stock comes in a variety of forms. Some have cumulative dividends. Some do not,” says Silk. “Investors considering preferred stock to lock in yield should do their homework on each issue they buy, and as with corporate bonds, only more so, should diversify their holdings.”
Ed Mahaffy, CEO and senior portfolio manager at ClientFirst Wealth Management in Little Rock, Arkansas, says preferred shares can play an important role in a portfolio by providing generous yields. He cites the iShares Preferred and Income Securities ETF (ticker: PFF), with a 12-month trailing yield of 6.3%.
“Although a notch above common stock in a bankruptcy proceeding, preferreds are still subordinate to bonds, even unsecured debenture bonds, in the pecking order,” he cautions. “Moreover, they can present significantly more credit risk than bonds.”
Defined-Maturity ETFs
A defined-maturity ETF holds bonds with a specified maturity date. Unlike traditional ETFs, it liquidates and returns capital to investors at the end of its term. This structure provides targeted exposure to bond markets with reduced interest rate risk.
For example, the Invesco BulletShares 2025 High Yield Corporate Bond ETF (BSJP) tracks a portfolio of high-yield corporate bonds with effective maturities in 2025. Its 12-month trailing yield is 7.2%.
“Like Treasurys, defined-maturity ETFs offer the ability to dovetail maturities with certain liquidity needs,” says Mahaffy. “As always, pay attention to the operating costs, but these can be viable alternatives to Treasurys notwithstanding the difference in creditworthiness.”
Certificates of Deposit (CDs)
Many investors like the idea of locking up cash in a certificate of deposit, or CD, which guarantees a return for a certain holding period. For example, several one-year CDs currently have rates of a little over 5%.
CDs are savings vehicles, not investments, because CD owners aren’t putting their money at risk as they do when investing in the stock market. In a broad market downturn, CD owners protect their capital, but that may come with the opportunity cost of limiting their upside during a market rally.
“CDs with longer terms can lock in high yields, specifically with the anticipation of interest rate cuts,” says Kovar. “Laddering CDs with staggered maturities can provide higher liquidity, minimizing interest rate risk.”
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How to Lock In High Yield Before the Fed Cuts Interest Rates originally appeared on usnews.com
