The Roles of Dividend and Interest Income
Investment income is an important part of total return (price change plus investment income from dividends and interest). For consistency, we’ll refer to investment income as yield – income received stated as a percentage of the security price – which is becoming increasingly important to investors. Following the volatility since the global financial crisis, many investors allocated away from risk assets, but many haven’t ratcheted down their return objectives – thus increasing the need for yield.
Ask these questions when evaluating yield instruments:
1. What’s the yield or income required on a regular basis? What’s the total return necessary to achieve my objectives?
2. What risks and volatility am I willing to tolerate to meet the yield and return objectives?
3. How is the current market environment impacting the level of yield that can be expected?
4. What trade-offs are necessary to earn higher yields?
Investors commonly assess yield based on expectations they formed from experience, but they must recognize the current environment is always changing and their yield expectations need to be adjusted accordingly. Achieving the yields they obtained in the past might require different asset classes, which likely entails increased risks.
Risk/Return Trade-Off. As investors pursue yield opportunities, it’s paramount to factor in the risk/return trade-offs associated with various investments. Whether the search for increased yield is driven by wanting to offset lower expected price appreciation or unrealistic expectations, investors must know that higher-yielding investments are often characterized by higher risk. We caution against chasing higher-yield opportunities without full consideration of the risk/return trade-offs.
Higher-yield Options. Traditional bonds and dividend-paying stocks have historically provided average yields, lower volatility and moderate total return. Less-traditional yield options (high-yield bonds, REITs, preferreds or convertibles) generally have above-average yields and total return potential, but also higher volatility and susceptibility to periods of negative performance.
Yield has historically accounted for a meaningful portion of total return, especially in lower-return environments. As such, adding different instruments to access yield opportunities may enhance a portfolio. However, the differences in yield between investments are a result of the risks associated with an investment. Balancing the risk and return trade-offs is an important step in constructing a suitable portfolio.
For more information, please contact your Financial Advisor.
This is not a complete analysis of every material fact regarding any investment. The information has been obtained from sources we consider to be reliable,
but we cannot guarantee its accuracy. Past performance is not a guarantee of future results. Diversification does not insure against loss.
All investments or investment strategies involve risk. Investors should consider the investment objectives, risks, charges and expenses of an investment carefully before investing. This and other information can be obtained by contacting your Baird Financial Advisor.
Robert W. Baird & Co. does not offer tax or legal advice.