Next week, we observe Labor Day, which honors all the hard-working men and women in the United States. As an investor, you’d like to think that all your investments are working hard, too — including the ones that are producing income.
But can your income-oriented investments be productive when short-term interest rates are at historic lows? Or can you find other investment possibilities that could potentially boost your cash flow?
The answer to both these questions is “yes” — but you may have to take a closer look at where you stand on the risk-reward spectrum.
For example, you might need to consider longer-term income producers, which typically pay higher yields than shorter-term equivalents. Longer-term fixed-rate securities, such as bonds, must pay these higher rates to reward investors, who face both interest-rate risk — the possibility that interest rates will rise, causing the value of existing bonds to fall — and inflation risk, the threat of losing purchasing power by the time long-term bonds have matured. Still, you may be willing to accept these risks in exchange for the higher yields.
However, you may be looking for income producers that can work hard for you without having to hold them for a long period to maturity. This is because the “yield curve” — the line that plots the relationship between yield and maturity — is fairly steep right now, which, in English, means you can gain noticeably higher yields just by modestly increasing the maturity of your investments.
Your financial adviser can suggest some short-term and intermediate-term vehicles that may be appropriate for your needs. And while these rates will still not be as high as those offered by longer-term vehicles, they do offer flexibility — along with less interest-rate risk and inflation risk.
You can also help protect yourself from these risks by building a “ladder” consisting of short-, intermediate- and longer-term bonds and certificates of deposit (CDs). Once you’ve built your ladder, it can help you weather changing interest-rate environments. When market rates are low, you’ll still have your longer-term bonds and CDs earning higher interest rates. And when market rates rise, you’ll be able to reinvest your maturing short-term investments at the higher levels. If you need the cash, you can liquidate the maturing bonds and CDs.
Thus far, we’ve only looked at fixed-rate investments — but you may also be able to boost your income by owning dividend-paying stocks. Some companies have paid — and even increased — their stock dividends for many years in a row. If you’re not in need of the cash, you can reinvest the dividends and boost your ownership stake, which is a key to increasing your wealth. But if you do need the money, you can take the dividends as cash.
Keep in mind that income producers are not a “sure thing” because companies can decide to reduce, or even discontinue, their dividends at any time. In addition, history tells us that you may experience more price volatility from stocks, and they can be worth more or less than the original investment when sold.
As you can see, you can find ways to keep income-producing investments working hard for you, despite the prevailing low interest rates. So consider your options, weigh the risks — and then work with your financial advisor to make those choices that are right for you.
This article was written by Edward Jones for use by Laura Evans, Edward Jones financial adviser of Richmond Hill.