Nobody was trying to personally hurt you. But your portfolio – and income – has been suffering as a result.
That’s because in the wake of the Great Recession, the Federal Reserve took aggressive steps to support the U.S. economy. They took out all the stops and quickly lowered interest rates from 5.25% to 0.25%.
When that happened, income investors had to change course. It was no longer possible to earn 3% from CDs, 4% from 10-year U.S. Treasurys, 6% from corporate bonds or more than 10% from junk bonds.
The solution was simple: dividend stocks. The media, financial commentators and even the research analysts here at Wyatt Investment Research recommended that income investors sell fixed-income investments and buy dividend stocks.
Many investors reacted by rushing into the highest-yielding stocks. With share prices down from their highs, dividend yields were attractive. Compared to the alternative – 0% at the bank or 2% with bonds – high-yield stocks seemed pretty sweet.
But since the Federal Reserve dropped the federal funds rate to a range of 0%-0.25%, stocks have roared higher.
Fed Drops Interest Rates: S&P 500 Up 138%
The problem is that the highest-yielding stocks haven’t done particularly well. In fact, the higher the yield, the worse the performance.
Unfortunately, many income investors mistakenly flocked toward stocks with the highest yields. These included companies that are “tax advantaged” – including business development companies (BDCs), master limited partnerships (MLPs) and real estate investment trusts (REITs).
Since 2009, the prices of these special classes of stocks have dramatically underperformed the S&P 500. Even after factoring in those healthy dividends, these investments have fallen short.
Dividend stocks have fared much better. Since early 2009, the iShares Select Dividend ETF (NYSEArca:DVY) is up 90%. Today the ETF yields 3.1%. That’s not a huge yield, but it’s 61% more than you would collect investing in the SPDR S&P 500 ETF (NYSEArca:SPY).
While the extra income is nice, the capital returns are far more important for long-term investors. And the bottom line is that the S&P 500 has done better than BDCs, MLPs, REITs or dividend stocks since the Fed lowered interest rates.
That’s right. Over the last six years, your investment portfolio would have been best invested 100% in the S&P 500 index.
Blame the Federal Reserve
You can blame the Fed for the current situation. Former Fed Chairman Ben Bernanke and current Chairwoman Janet Yellen have been working to keep rates at record lows for a prolonged period.
Zero percent interest rates helped stabilize the languishing U.S. economy in 2009 and 2010. But they also created an impossible environment for income investors.
An extended period of 0% interest rates is completely uncharted territory. And it’s unknown how financial markets will react when the Fed starts raising interest rates.
Unfortunately, the Fed remains extremely cautious. That apprehension is appropriate – since much is at risk. But it also comes with a cost.
Thus far in 2015, stocks have been moving sideways. High-yield investments have been losing value, based on a fear that rising interest rates could increase borrowing costs and hurt profits.
The Fed’s delay in increasing interest rates is only creating more uncertainty. With the economy improving, now is the time for the Fed to gradually start raising interest rates. Janet Yellen should raise the fed funds rate by 0.25% at the Fed’s September meeting.
This article is brought to you courtesy of Ian Wyatt from Wyatt Investment Research.