A basic investing rule is being re-taught to people who bought a variety of investments in an attempt to work around low interest rates.
The more you get in yield, the more risk you take on. There is no bonus yield out there. It always comes at a price.
You'll already know that if you loaded up on dividend stocks, preferred shares or high yield bonds at the expense of bonds. In each case, prices have fallen sharply in 2015. In each case, a basic bond fund would have been the better holding for the year to date.
Or so hindsight tells us, anyway. What matters now is what you're going to do moving forward. Suggestion: Consider buying more of those dividend stocks, preferred shares and maybe even high yield bonds. The logic for investing in them at the expense of bonds is just starting to make sense.
Now for a disclaimer about bonds. Even with low yields and the risk of rising rates somewhere ahead, you need to have some bonds in your portfolio. There's an old rule about building portfolios that says your stock weighting should equal 100 minus your age. The difference is your allocation to bonds.
This is actually an outdated guideline. With people living longer, we should look at 110 or even 120 minus our age. The extra exposure to the stock market dictated by this shift can go into dividend-paying stocks, preferred shares and high yield bonds (risk-wise, they behave more like stocks than bonds).
Now's a good time to start making this move because you're selling high if you ease back on bonds. Bonds rise in price when we have low interest rates, and fall when rates rise. This year's notable rate moves have been on the down side.
Conversely, the kinds of investments that people have been using as bond substitutes have been kicked hard this year and thus offer an opportunity to buy low. Note that it's mainly prices that have fallen for dividend stocks and preferred shares. A few commodity companies, such as Cenovus Energy and Goldcorp, have recently cut dividends, but mainstay dividend payers have been solid.
Let's look at preferred shares. The S&P/TSX preferred share index was down 14.1 per cent for the year through July 30, a major decline when you consider that these shares are supposed to be a docile investment for no-drama income seekers.
The preferred share market is dominated today by a type of security, the rate-reset preferred, that was designed to be in its element when rates were rising. Falling rates have led to heavy selling of these shares and yields are rising. If you bought an exchange-traded fund tracking the S&P/TSX preferred share index (the iShares S&P/TSX Canadian Preferred Share Index ETF), your monthly payouts would produce a yield of about 5.3 per cent. Five-year Government of Canada bonds had yields around 0.8 per cent in late July.
Dividend stocks are a buy-low opportunity, too. Banks and energy stocks account for a big piece of Canada's dividend-paying universe and both sectors have been dumped on this year. The S&P/TSX Canadian Dividend Aristocrats Index was down 8.3 per cent for the year to July 30, much worse than the 1.7-per-cent drop by the more broadly diversified S&P/TSX composite index.
A similar story can be told about high yield bonds, which are a speculative type of bond issued by financially weak companies and in no way comparable to conservative government or blue chip corporate bonds. The high yield sector has been hurt by weakness in the energy sector, a major issuer of this type of bond. There's also concern that a hike in interest rates in the United States could increase the default rate for high yield bond issuers. Higher rates mean higher financing costs, and these companies aren't strong to begin with.
Making a big move out of bonds now, or anytime, is a market-timing move that has a monumentally good chance of backfiring on you. Sell bonds now and you lose your cushion against a stock market crash or a recession.
So keep almost all your bonds and consider an incremental move into dividend stocks, preferred shares or high yield bonds to boost your overall yield. A move like this makes more sense now than it did before.