Looking for Income?
by Richard Pignone, Mark Franco, and Elizabeth McClelland ◊ Jun 17, 2011
We all know, only too well, that the “usual” places we save money (savings accounts, money markets, CDs, etc.) aren’t paying us much, if anything. Interest rates are among the lowest they’ve been in many years. So, where do you put your nest egg where it will earn more than nothing and be available when you need or want it and have some level of safety?
Some investors immediately think of fixed-income (bond) investments as an alternative way to meet their income needs. Many bonds pay interest at regular intervals and, if you hold the bond to maturity, you will also receive the principal face value of the bond back. Typically, the longer the maturity on a bond, the higher the interest rate. Also important is the fact that most bonds can be sold at anytime if you find you have an unforeseen need for cash, and many of them are backed by insurance of one sort or another. Of course, there are always exceptions to every rule and there have been instances in the last few years where bonds, both backed by a municipality or a corporation, have had liquidity problems. But, in general, people feel bonds are a reasonably safe place for a portion of their savings.
There is an issue with this train of thought, though. Interest rates and bond prices trade in an inverse relationship to each other. In other words, as interest rates go up, and I think we can all agree they can’t go much lower, the value of a bond will go down. So, as an example, you buy a $10,000 bond that pays you three percent and matures in 10 years. Three percent is a lot better than the average savings account right now. However, if interest rates go up and you need access to those funds before the bond matures in 10 years, chances are the price of the bond will have gone down and you won’t get back all of your original investment.
Another possible income-producing alternative is investing in dividend-paying stocks. Unlike bonds paying a fixed rate of return, dividends can potentially increase over time, which helps increase your income and keep pace with inflation. At the same time, it is important to remember that companies can decrease their dividend at any time or eliminate it altogether.
However, companies with a long track record of paying dividends to shareholders through all kinds of market environments may be worth considering. A company’s ability to consistently pay – and increase – dividends is also an important sign of that company’s financial strength. While past performance is not a guarantee of future results, dividend-paying stocks have also historically performed well relative to non-dividend paying stocks during periods of rising interest rates.
Keep in mind that after the turbulent markets of 2008 and 2009, corporations tightened their purse strings to such a degree that they are now sitting with historic levels of cash on their balance sheets. There are many ways for them to put that cash to work: mergers and acquisitions, initiating dividends, increasing dividends, or paying a special dividend, to name a few.
Investing in stocks is not for everyone. It entails certain risks, including the potential loss of all or a portion of the proceeds invested. You should consider your financial needs, investment objectives, and risk tolerance before making an investment. As always, before taking any action, it’s a good idea to talk to an investment professional about your specific situation.
The Hamden branch of Benjamin F. Edwards & Co. is located at 2321 Whitney Avenue, Suite 502, Hamden, CT 06518. To reach the Benjamin F. Edwards & Co. by phone, please call 203.287.9266 or toll free at 877.344.0499. Also, please visit www.benjaminfedwardsco.com.