Here Comes the Fed! What’s the Play for Income Investors?

Apparently the markets are putting the odds of a rate hike next month at 74%. The financial media is raising the hue and cry, as if this is some monumental event that requires bond and fixed income investors to immediately rejigger their portfolios to respond to this act.
Hold your horses.
Let’s start with the fact that a rate hike is not guaranteed. If you make a move expecting a hike and it doesn’t occur, you are making decisions based on emotion, and not on rational thought with an eye towards your financial plan.
First of all, if you are a bond investor, you should have a laddered strategy that accounts for a possible rate hike. That’s where you have bonds of different maturities and different issuers stacked in such a way that every few months some bonds mature and you can roll the proceeds into a different one.
Thus, if rates go up, then hopefully you have some bonds maturing at year-end. You can then re-invest the proceeds in bonds that now have higher rates.
In the grander scheme of bond investing, a quarter-point hike is not going to meaningfully change any kind of monthly income. Nor should you expect the Fed to follow this hike with several more in close proximity. It is going to watch and wait and see how any hike impacts the economy.

What About Fixed-Income Investing?

That takes us to the broader issue of fixed-income investing. The prevailing wisdom is that as bond yields rise, other interest or dividend-paying securities are going to suffer, since rising bond yields will compete with what they pay.
That’s true, but again, interest rates are at historic lows. It’s going to take a whole lot of hikes to get bonds to the point where they even compete with anything else.

Blue Chips and REITs

For those of you holding blue chip dividend stocks, chances are those stocks are paying around 3% or so. Those are going to be the first securities to see competition, but that’s a very long way off. So I wouldn’t sell anything just yet.
For holders of real estate investment trusts, those securities are even further out from any near-term effect. Most REITs are yielding 4% or more, and some as high as 6%. The trick with both dividend stocks and REITs is that when – and I stress again that this is a very long way off – bond yields get into the 3-5% range, these equities will likely see some selling. Investors want to move to safer plays like bonds and away from stocks if they are only in it for the yield.
Exchange-traded debt (ETD) is a different beast. This is basically corporate debt, but not junk debt. ETDs are effectively bonds that are issued by corporations, that trade like stocks. However, their practical level of risk is actually not that different than government bonds. They pay 6% or more, often closer to 7%, so bonds would have to be in the 5% to 5.5% range before these sell off.
Finally, you have preferred stocks. Like ETDs, there’s just very little practical risk here, and they yield 7% to 9%. It could be 5 to 10 years before bonds even come close.
In short, there’s little reason to make any moves. You should have laddered bonds, and a long-term diversified portfolio of other income stocks, to account for events just like this.

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