Dear Mike: What are my options for generating more yield from my portfolio?
Gary in Langford
If you depend on fixed-income investments for at least part of your income, you probably haven't been too happy in recent years as interest rates have hit historic lows. Nonetheless, even in a low-rate environment, you can broaden the income-producing potential of your investment portfolio.
Before taking action, it's helpful to know what the direction of interest rates may look like. The Bank of Canada has kept its short-term target interest rate at low levels, and the U.S. Federal Reserve Bank has pledged to keep short-term interest rates near zero until 2015. However, this doesn't mean that other interest rates can't rise sooner. The Bank of Canada and the U.S. Fed actions play a key role in determining interest rates, but ultimately rates should begin to go up if market participants believe the economy is on the right path and economic growth accelerates.
In any case, rather than worry about something you can't control, try to focus on things you can accomplish.
One achievable goal is to create an investment mix that includes three types of income:
? Variable income investments: Short-term GICs can be considered variable because they will mature relatively quickly and thus must be reinvested at current market rates. GICs offer significant protection of principal and the value of your investment won't change with fluctuating interest rates, provided you hold your GIC until maturity. Of course, current rates are quite low, which means GICs provide you with little income today, but their rates have the potential to rise along with short-term interest rates.
? Reliable income investments: When you purchase reliable income investments, which can include individual bonds, you have the opportunity to earn more income today, and more consistent income over time, than you would typically get from variable income investments. However, you will likely also experience greater price fluctuations as interest rates change. Specifically, as interest rates rise, the price of your existing bonds typically will fall.
? Rising income investments: When investing for income, you will want to keep at least one eye on inflation. If the interest rates paid on your GICs and individual bonds are lower than the annual inflation rate, you may lose purchasing power. If this gap persists over time, it could grow into a real problem. Consequently, you will want at least some of your investment income to come from rising income investments, such as dividend-paying stocks. Of course, not all stocks pay dividends, but with the help of your financial adviser, you can find companies that have paid - and even increased - dividends for several years running. And if you don't actually need the dividends to supplement your cash flow, you can reinvest them to build your ownership stake in these stocks. Keep in mind, though, that companies can increase, decrease or eliminate dividends at any time without notice. Also, remember that stock prices will constantly rise and fall, so the value of your principal could decline.
All three types of income-producing investments offer some benefits, along with some risks of which you need to be aware. But putting together a mix of these investments that's appropriate for your individual needs, goals and risk tolerance may help you boost the productivity of the "income" portion of your portfolio - no matter what's happening with interest rates.
Bonds may be subject to certain risks, including interest rate risk, credit risk, re-investment risk, market and currency risk.
The values of bonds fluctuate, and you may lose some, or all of your principal.
Diversification does not guarantee profit or protect against loss.
Mike Watkins, CFP, FMA, FCSI, CSWP
Watkins is a financial adviser with Edward Jones, author of the financial planning guide It's Only Money and a member of the Canadian Investor Protection Fund and Investment Industry Regulatory Organization of Canada. To ask a question, call 250-418-0114.
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