Article Highlights:
- Low interest rates mean your bond portfolio is losing money.
- There is a special type of asset that benefits from low interest rates.
- If you pick the right ones, it’s a safe way to achieve high yields plus price appreciation.
Shhh, listen. Hear that giant sucking sound?
That’s the sound of your investment income being sucked away by low interest rates.
Potential earnings are gushing through a hole in your investment dam.
Low interest rates aren’t everyone’s friend.
The way the financial press — and President Donald Trump — talks, you’d think interest rates were the most important single thing that shapes everybody’s prosperity.
That’s nonsense.
In the short term, the only people who benefit from low interest rates are borrowers and stock investors. The rest of us — especially retirees! — suffer declining income from our investments in bonds and other fixed-income securities.
The financial press only cares about the stock market. Interest rates are a fetish for them. They ignore rates’ negative impact on the rest of us, as if we don’t exist.
If you’re an investor relying on bond investments, whether in Treasurys or corporate debt, your portfolio has probably been trashed over the last few years.
But I can help you solve that problem … not just temporarily, but permanently.
Paradoxically, in my system, low interest rates are going to bring you more income … income you won’t find anywhere else!
Safety, but No Numbers
If you’ve been playing it safe and relying on bonds for income, this year’s been bad news.
If you’ve been following the standard 60% stocks/40% bonds portfolio strategy, you’re taking a beating on that 40%.
On January 1, a 10-year Treasury bond returned 2.66%.
On Friday last week, it yielded 1.86%.
You can get better returns than that in a savings account or a certificate of deposit!
Corporate bond yields are a little better, but even the best-quality bonds are only paying about 3.35% right now:
Junk bonds — debt issued by companies in financial distress — are yielding a bit more. But as interest rates fall and these companies load up on even more debt, the risk of investing in junk bonds becomes intolerable.
So what are you going to do to plug the hole in your investment dam?
REITs Redux
On July 31, I wrote about real estate investment trusts, or REITs.
Companies of this special type invest in real estate or mortgages. They don’t pay corporate income tax, but to enjoy that status, they must pay out 90% of their net income as dividends.
I pointed out that, because of this special tax treatment, REITs have exceptionally high yields. More than half of the REITs that I track have annual yields in excess of 5%.
That makes them an attractive alternative to bonds in a low-interest-rate environment.
In fact, REITs — and their shareholders — benefit from low interest rates in two ways:
- Investors seeking better yields than they can get in bonds buy shares of REITs when interest rates fall. That pushes up REITs’ share prices. That’s why the Vanguard Real Estate exchange-traded fund (NYSE: VNQ), which tracks REITs, has comfortably outperformed the S&P 500 Index this year:
- Because REITs are required to distribute so much of their income as dividends, they typically finance expansion through borrowing. Low interest rates mean better margins. For example, retail REITs borrow money to build new shopping centers. But the rents they receive on the shopping centers are determined by supply and demand for retail space. Well-run REITs can earn a large rental income premium over their borrowing costs, which rises even further when interest rates fall. That makes them more valuable, pushing up their stock price as well as their dividends.
Of course, there’s a lot more to REITs than interest rates. In fact, they’re hidden gems buried in some of today’s most explosive growth sectors.
For example, Big Data stocks such as Amazon and Google need specialized buildings to hold the massive server farms that underpin their businesses. That’s why data center REITs are up 21% this year, compared to 14.5% for the S&P 500.
Or take industrial warehouse REITs, two of which I’ve included in my Bauman Letter’s Endless Income portfolio. An index of these REITs is up almost 27% this year as companies such as Amazon try to grab urban warehouse space to support one-day delivery promises.
The biggest winner of all is cell tower REITs, which invest in the land under those essential structures. An index of those REITs is up over 40% this year!
Invest in REITs the SAFE Way
But what about safety?
The standard 60% stocks/40% bonds portfolio is there for a reason. That 40% in bonds is supposed to give you safety and balance the risk of investing in more volatile stocks.
This is where an investment service such as The Bauman Letter comes in. I carefully analyze every REIT I consider to ensure that it meets my SAFE criteria:
- Steady dividend growth. I look for a long track record of uninterrupted increases in dividends, which indicates a successful and well-managed company.
- Strong stock price Action. As I showed you in respect to data center, industrial warehouse and cell tower REITs, some specialty REITs benefit more than others. Those are the ones I want to recommend for you.
- Rising Funds from operations (FFO). FFO is a special metric I use to evaluate whether a REIT is benefiting from a successful business model, or trying to hide behind sales of assets and other financial engineering to appear successful.
- A sustainable relationship between Earnings and dividends. I look for REITs that pay out around 60% of their annual earnings as dividends and reinvest the rest in growth. That’s what is going to give us strong and rising dividends in the future.
So … plug the hole in your financial dam caused by low interest rates by targeting REITs via my SAFE system!
Kind regards,
Ted Bauman
Editor, The Bauman Letter