This has been an awful year for equity and fixed income investing. The S&P 500 is down over 24% so far this year. And there is a good chance it gets worse. U.S. investment-grade bonds, as measured by the Vanguard Total Bond Market Index, on the other hand, are down 15% YTD.
Inflation is still high. The Fed is still being aggressive. And a recession increasingly seems inevitable. Investors just can’t shake off that mess. Buying the dips hasn’t worked. Four times this market rallied over 5% this year only to pull back to new lows. Eventually, stocks will bottom, and a new bull market will begin. But maybe not for a while.
But there is some good news for income investors. Interest rates are higher than they have been in a long time. The benchmark ten-year Treasury yield has soared from 1.51% at the beginning of the year to near 4% today. The yield is the highest in more than a decade. Investment-grade bonds and other fixed-rate investments are now yielding 5% or 6%.
Interest rates are decent again for the first time in a long time. Fixed-rate investments are no longer offering a measly 2%. A crucial element of a portfolio is born again.
Historically, bonds and other fixed-rate investments have been a safe port in the storm during bear markets. They typically maintain their value while providing an income at the same time. Having a fixed-rate element in a portfolio lowers overall risk and downside and makes it easier to stay invested in down markets. Plus, they provide another source of income without the treachery of stocks in a year like this.
Of course, a reasonable case can be made that rates may go still higher. That’s bad for fixed income investing in the near term as bond values decrease when rates rise. It’s already been one of the worst years on record for bonds amid spiking interest rates. And there may be more pain in the months ahead. But consider the longer term.
Bonds are typically longer-term investments than stocks. They’re income and diversification vehicles, not trading fodder. While rates could certainly spike higher in the near term, it is far less likely that rates average higher than today’s level over the next five years or so.
It’s true that interest rates have been far higher than today in past decades. But the world has changed. The government will be reluctant to tolerate much higher rates with $31 trillion in debt. It’s as bad or worse in many other countries. The rate increases so far are already driving the U.S. and global economy into recession. Sure, this might not be the bottom. But it should be a good move for the longer term to lock in rates at a 12-year high.
Fixed Income Investing Through Preferred Stocks
Invesco Preferred ETF (PGX)
Most people think of bonds when they think of fixed income investing. But there are other kinds of fixed-rate investments including CDs, annuities, and preferred stock.
Preferred stock is a class of ownership in a corporation that has features of both stocks and bonds. They are like bonds in that make they both make regular payments that don’t change and are backed by the issuing organization. They also both move up and down in price with interest rates. They also come with ratings and are senior to common stock in that preferred dividends are a priority and paid out first.
Preferred stocks also offer advantages that bonds don’t. The main advantages are generally higher rates than similarly rated bonds, daily liquidity, and tax advantages. Most preferred stock dividends are only taxes at the top 15% rate (or 20% in some cases) unlike bond interest that is taxed at ordinary income tax rates.
The Invesco Preferred ETF (PGX) portfolio is based on The BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index which tracks the performance of fixed-rate ,U.S. dollar-denominated preferred securities issued in the U.S. domestic market. The portfolio currently consists of 296 different issues.
A fund like this has several advantages over an individual issue. With so many different securities, you diversify away from the risk associated with any one company or issue. There is also no risk that the fund, like an individual issue, can be called away. But perhaps the biggest benefit is that it pays dividends every single month and can make a great addition to your investment cash flow.
Most of the issues are investment-grade rated based on the following breakdown (as of 10/10/22): A – 1%, BBB – 58%, BB – 33% B – 2% and 6% not rated. Only less than 4% of the portfolio is invested in companies based outside the U.S. PGX is better diversified by industry than most similar funds and ETFs. The vast majority of preferred stocks are issued by the financial industry, but PGX is spread in other industries. The portfolio is about two-thirds in Financials (68%) and the largest allocations in other industries include Utilities (11%), Real Estate (8%) and Communication Services (7%).
PGX offers a higher rate on mostly investment-grade investments than has been available in years. It’s a great way to lock in a high income and diversify away from stocks at a time when interest rates are at a 12-year high.
To learn more about other income-generating investments and how to boost your dividend returns, subscribe to Cabot Income Advisor today!