Investment strategists say an increasingly popular investment strategy, especially among retirees or retiring people, needs to be put into pasture.
That’s the dividend conversion.
For much of the past decade, investors have been operating in the context of two big trends: historically low interest rates, which left retirees struggling to live on income. Share prices rise, encouraging market risk.
As a result, many investors have been buying and selling low-interest bonds as dividend-paying stocks during the bull market, hoping to earn more and enjoy higher prices.
This explains why the dividend payments that historically traded at a discount to the broader market are now frothy compared with those of the s&p 500.
But while the strategy may be good for investors in the early stages of the rally that began in 2009, strategists say the risk is rising as the bull market goes on.
Lewis Altfest, chief executive and chief investment officer of Altfest Personal Wealth Management, said: “equities are a growth-oriented investment that carries a lot of risk, while bonds are a tool to reduce risk. “You shouldn’t put the two together, especially in this cycle.”
In the final stages of economic expansion, interest rates tend to rise as the economic recovery intensifies. Since the beginning of September, the yield on the 10-year Treasury note has risen from 2.04% to 2.38%. Meanwhile, the fed is expected to raise short-term interest rates by another percentage point on December 13.
The rise in fixed-income yields usually makes it less attractive to generate stocks, as dividends pay the attention of investors in stocks and bonds.
Jack Ablin, chief investment officer at BMO private bank, said: “another risk is that the dividend that ge has seen recently may itself be reduced.” The industrial giant has cut shareholder spending by 50 per cent. “Unlike bonds, companies have no obligation to continue paying dividends,” he said.
The most worrying, however, is how a retiree’s portfolio could be affected if the bull market is coming to an end. While it’s impossible to say how long the stock market will last, the bull market is nearly nine years old, twice as big as the typical rally. Financial advisers worry that when markets finally sell, investors who swap bonds for equities will be aware of the real risks involved in the strategy.
The potential risk of major stock market losses in retirement or close to retirement age older investors especially threatening, because they have little or no time to make up for the losses, and then you can open account.
“If you’re facing a downturn at some point in your retirement, and you’re too exposed to stocks, it could ruin your entire future,” says Altfest.
So what should investors do?
The first step is to re-examine their basic investment strategies to ensure they stick to the right mix of stocks and bonds, even if that means less income, financial planners say.
But what if the retirees just needed more cash than the bond yields? The best source of cash flow may be hidden in the obvious. Investors can simply reduce some of their holdings and use earnings to meet their income needs.
Ultimately, this could be a safer strategy.