Challenges and Investment Opportunities in 2021
With the economy emerging from recession, the November elections behind us, and hope rising from the COVID-19 vaccine rollout, many investors look forward to 2021. While the S&P 500 hit record highs in 2020, interest rates are near record lows and income seekers may doubt there are alternatives to expensive and volatile stocks.
Despite low rates, opportunities exist for those investors whose primary investment objective is to generate income from their portfolios. Dividend-yielding stocks generally pay dividends quarterly from the company’s profits. Growing the dividend-based income takes time and consistency. Many investors choose to automatically reinvest dividends and begin potentially growing the earned dividends at the same rate as the principal, which multiplies their money at accelerated rate. Although hundreds of publicly traded companies reduced or suspended their dividends last year, looking ahead in anticipation of economic recovery, investors most likely will choose to embrace dividend-paying stocks as one of alternatives to lower-yielding fixed income instruments.
Preferred securities are another alternative to lower-yielding fixed income instruments. Preferred stock is a security that has properties of both an equity (stock) and a debt instrument (bond). Preferred stocks usually pay a fixed income, have a par value, hold a credit rating and trade on a major exchange. Preferred stocks are less volatile when compared to common stocks and have dividends that are paid out before dividends to common shareholders, however, there is less of a chance for price appreciation when holding preferred shares. Traditionally, preferred shares offer a higher annual dividend per share over common stock because the owner of preferred stocks gives up the right to vote on matters affecting the shareholders.
Demand for municipal bonds (bonds issued by local governments) by investors in higher tax brackets remains high. Additional supply of municipal bonds, both tax-free and taxable, may be brought to market in 2021 to help fund critical infrastructure projects in the U.S. because of a massive climate-friendly infrastructure spending bill proposed last year (if the bill passed this year). This new supply has a high probability of quickly being absorbed by higher yield-seeking municipal bond investors. Equity markets such as materials, industrials, energy, utilities, and telecommunication services can potentially also benefit from this bill.
In 2021’s low interest environment, a professionally managed, tactical approach to income investing that seeks opportunities in a variety of asset classes may help investors achieve their income goals.
Retirees also could use the “bucket approach” – using fixed-income and other investments – to plan for income over a multi-year period. An investor uses one bucket to cover their living expenses for five years (or longer time) by buying the appropriate fixed-income investments to match that time horizon. During that time, the remaining retirement assets can be invested to capture long-term equity growth.
With everything said, depending on many factors - including how long you have held a security - it also may be worthwhile upgrading your dividend stock holdings by replacing companies with weaker balance sheets — and more at risk of cutting dividends — with those whose financials suggest they are in better shape to continue paying. Some companies have consistently paid dividends for decades*. Please consult your financial advisor before doing that. In addition to dividend-paying stocks, a more diversified portfolio might hold real estate investment trusts, convertible bonds, and emerging-markets debt.
For long-term investors, stocks remain a likely source of gains even if short-term declines occur. Growth is risky when it is at an exceedingly high valuation**. Valuations look more attractive for value stocks after years of surging growth stocks.
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* 13 Dividend Stocks that Have Paid Investors for 100+ Years/Kiplinger, May 21, 2020
** 5 Strong Buy Stocks at Attractive Valuations/Nasdaq, January 21, 2021