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Oct

2023

What Is the Yield Curve? How It’s Used as a Market Indicator

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

The yield curve itself is a basic graph of the interest rates paid by bonds at different maturities (e.g., two-year, five-year, 10-year bonds). But many investors interpret the slope of the yield curve as a harbinger of what might lie ahead for the U.S. economy.

The yield curve can be an indicator of economic expectations, but not a reliable predictor of events. That said, analysis of historical data patterns shows that understanding the yield curve can be useful for investors.

4 Types of Yield Curves and What They Mean

The yield curve is published by the Treasury every trading day. It reflects the yield or interest rates paid by Treasury securities for one-month through 30-year maturities. The Treasury’s figures also help to set the rates for other debt securities on the market, as well as mortgages and other loan rates offered by banks.

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What is a yield curve, and what does it look like? Here are four common yield-curve patterns and what each might mean for investors.

1. Normal Yield Curve

Under ordinary conditions, longer-maturity bonds will offer a higher yield to maturity than shorter-term bonds. For that reason, the “normal” yield curve shape has an upward slope, with longer-maturity debt providing investors with higher interest rates.

For example, imagine that a two-year bond offers a yield of 0.5%, a five-year bond offers 1.0%, a 10-year offers 1.8%, and a 30-year offers a yield of 2.5%. When these points are connected on a graph, they exhibit a shape of a normal yield curve. It is the most common type of curve, and tends to indicate a positive economic outlook.

2. Steep Yield Curve

Just as a normal upward-sloping bond yield curve is associated with periods of economic expansion, a steep yield curve is seen by investors as an even stronger sign of economic growth on the horizon — as future yields rise higher to take possible inflation into account.

Another reason that a steep yield curve might indicate periods of stronger growth is that lenders are willing to make short-term loans for relatively low interest rates, which tends to stimulate economic activity and growth.

In late 2008, the yield curve became notably steeper, as the Federal Reserve eased the money supply in response to the financial crisis. A bull market followed that lasted over a decade, from 2009 to 2020.

3. Inverted Yield Curve

Bond yield curves aren’t always normal or upward-sloping. With an inverted yield curve, for instance, the yields for shorter-term debt are higher than the yields for longer-term debt. A quick look at an inverted yield curve will show it curving downward as bond maturities lengthen, which can be a sign of economic contraction.

Since 1955, an inverted yield curve has preceded most, if not all U.S. recessions that have occurred. Usually, the curve inverts about two years before a recession hits, so it can be an early warning sign.

The reason is that, historically, an inverted yield curve can reflect significant shifts in the economy or financial markets. The yield curve might invert because investors expect longer-maturity bonds to offer lower rates in the future, for example. One reason for those lower yields is that often during an economic downturn investors will seek out safe investments in the form of longer-duration bonds, which has the effect of bidding down the yields that those bonds offer.

Inverted yield curves are uncommon, and sometimes decades will pass between them. In October 2007, the yield curve flattened (which can precede an inverted yield curve) precipitating the global financial crisis.

4. Flat and Humped Yield Curves

There are also flat or humped bond yield curves, in which the yields of shorter- and longer-term bonds are very similar. While a flat yield curve is self-explanatory, a humped yield curve is one in which bonds with intermediate maturities may offer slightly higher yields. Those higher yields in the middle give the curve its hump.

Investors see flat or humped yield curves as a sign of a coming shift in the broader economy. They often occur at the end of a period of strong economic growth, as it begins to spur inflation and slow down. But these yield curves don’t always portend a downturn.

Sometimes a flat or humped bond yield curve may appear when the markets expect a central bank, such as the Federal Reserve, to increase interest rates. Flat and humped markets can also emerge during periods of extreme uncertainty, when investors and lenders want similar yields regardless of the duration of the debt.

What Is the Current Yield Curve?

2y10y treasury spread 1977-2022

When investors ask, What is the yield curve?, it’s important to remember that it’s not a fixed market factor, but one that changes daily.

Here’s an example: On October 5, 2021, the three-month Treasury bill paid an interest rate of 0.04%, while the two-year bond paid an interest rate of 0.28%, the five-year bond paid an interest rate of 0.98%, the 10-year bond paid an interest rate of 1.54%, and the 30-year bond paid an interest rate of 2.10%.

The yield curve on that day, with lower short-term yields that rise as the duration of the debt security grows longer, is a good example of a “normal” yield curve.

The difference between the 0.04% yield offered by the three-month T-bill and the 2.10% yield offered by the 30-year bond on Oct. 5, 2021, was 2.06%. At the beginning of August, the three-month Treasury bill paid an interest rate of 0.05%, while the 30-year Treasury bill paid an interest rate of 1.86%. The difference at that time was 1.81%. So it would be accurate to say that the yield curve is normal, and grew somewhat steeper over the course of about two months.

How Investors Can Interpret the Yield Curve

The yield curve has value for investors as an indicator of a host of economic factors, including inflation, growth, and investor sentiment. While it can’t be used to make exact predictions, the yield curve can help investors anticipate potential economic changes, and weigh their financial choices in light of this. The yield curve can’t necessarily help investors choose individual stocks, but it can be of use when formulating broad investment strategies.

For example, if a flat or inverted yield curve indicates the possibility of an economic slowdown, then it might be a good time to purchase the stocks of companies that have historically done well during economic downturns, such as providers of consumer staples.

But if the yield curve is steep – indicating economic growth and higher interest rates – it may be worth considering adding more luxury-goods makers and entertainment companies to your portfolio.

The yield curve also has ramifications for real estate investors. A flat or inverted curve could warn of a slowdown and a drop for current real estate prices. But a steepening of the yield curve can mean just the opposite for real estate.

Changes to the yield curve have the most profound implications for fixed-income investors, however, as steep yield curves indicate that inflation is on the way. And inflation has the effect of eroding the yields on existing bonds, as the purchasing power of those yields goes down.

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Fixed-income investors also face unique challenges in the rare event of a yield curve inversion. Many investors are accustomed to earning a higher yield in exchange for longer debt maturities, but in an inverted curve, they can no longer find that premium. As a result, many of these investors will opt for shorter-term debt instruments, which offer competitive rates, instead of getting locked into the low rates offered by longer-term bonds.

Recommended: Short-Term vs. Long-Term Investments

The Takeaway

The yield curve may be just a basic graph of the interest rates paid by bonds of different maturities, but historical data shows that the yield curve can also be a useful economic indicator for investors. You don’t want to take it too far and assume the yield curve can predict economic events, but since the yield curve is published every day by the U.S. Treasury, it can capture certain economic shifts in real time.

With a normal yield curve, short-term bond rates are lower than long-term bond rates, and the curve swoops upward — which is a positive economic indicator, suggesting steady economic growth and investor sentiment. When short- and longer-term bond rates are similar, and the yield curve flattens, that can indicate that some economic changes may be afoot. Historically, when the yield curve inverts and short-term bond rates are higher than long-term rates, that can signal a recession might be down the road.

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Oct

2023

What Is Yield?

By SoFi Editors | Growing Wealth, Investing, Terminology | No Comments

Yield is the income generated by an investment over a period of time. Yield is typically calculated by taking the dividend, coupon or net income earned, dividing the figures by the value of the investment, then calculating the result as a percentage.

Yield is not the same as return or the rate of return. Yield is a way to track how much income was earned over a set period, relative to the initial cost of the investment or the market value of the asset. Return is the total loss or gain on an investment. Returns often include money made from dividends and interest. While all investments have some kind of rate of return, not all investments have a yield, because not all investments produce interest or dividends.

How Do You Calculate Yield?

Yield is typically calculated annually, but it can also be calculated quarterly or monthly.

Yield is calculated as the net realized income divided by the principal invested amount. Another way to think about yield is as the investment’s annual payments divided by the cost of that investment.

Here are formulas depending on the asset:

= Dividends Per Share/Share Price X 100%
= Coupon/Bond Price X 100%
= Net Income From Rent/Real Estate Value X 100%

For example, if a $100 stock pays out a $2 dividend for the year, then the yield for that year is 2 ÷ 100 X 100%, or a 2% yield.

Cost Yield vs. Current Yield

One important thing to think about when doing yield calculations is whether you’re looking at the original price of the stock or the current market price. (That can also be referred to as the current market value or face value.)

For example, in the above example, you have a $100 stock that pays a $2 dividend. If you divide that by the original purchase price, then you have a 2% yield. This is also known as the cost yield, because it’s based on the cost of the original investment.

However, if that $100 stock has gone up in price to $120, but still pays a $2 dividend, then if someone bought the stock right now at $120, it would be a 1.67% yield, because it’s based on the current price of the stock. That’s also known as the current yield.

Rate of Return vs. Yield

Calculating rate of return, by comparison, is done differently. Yield is simply a portion of the total return.

For example, if that same $100 stock has risen in market price to $120, then the return includes the change in stock price and the paid out dividend: [(120-100) + 2] ÷ 100, so 0.22, or a 22% total return.

The reason this matters is because the rate of return can change if the stock price changes, but often the yield on an investment is established in advance and generally doesn’t fluctuate too much.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Definition of Yield for Different Investments

Yield in Stock Investing

When you make money on stocks it often comes in two forms: as a dividend or as an increase in the stock price. If a stock pays out a dividend in cash to stockholders, the annual amount of those payments can be expressed as a percentage of the value of the security. This is the yield.

Many stocks actually pay out dividends quarterly. In order to calculate the annual yield, simply add up all the dividends paid out for the year and then do the calculation. If a stock doesn’t pay a dividend, then it doesn’t have a dividend yield.

Note that real estate investment trusts (REITs) are required to pay out 90% of their taxable income to existing shareholders in order to maintain their status as a pass-through entity. That means the yield on REITs is typically higher than for other stocks, which is one of the pros for REIT investing.

Sometimes investors also calculate a stock’s earnings yield, which is the earnings over a year, dividend by the share price. It’s one method an investor may use to try to value a stock.

Yield in Bond Investing

When it comes to bonds vs. stocks, the yield on a bond is the interest paid—which is typically stated on the bond itself. Bond interest payments are usually determined at the beginning of the bond’s life and remain constant until that bond matures.

However, if you buy a bond on the secondary market, then the yield might be different than the stated interest rate because the price you paid for the bond was different from the original price.

For bonds, yield is calculated by dividing the yearly interest payments by the payment value of the bond. For example, a $1,000 bond that pays $50 interest has a yield of 5%. This is the nominal yield. Yield to maturity calculates the average return for the bond if you hold it until it matures based on your purchase price.

Some bonds have variable interest rates, which means the yield might change over the bond’s life. Often variable interest rates are based on the set U.S. Treasury yield.

Is There a Market Yield?

Treasury yields are the yields on U.S. Treasury bonds and notes. When there is a lot of demand for bonds, prices generally rise, which causes yields to go down.

The Department of the Treasury sets a fixed face value for the bond and determines the interest rate it will pay on that bond. The bonds are then sold at auction. If there’s a lot of demand, then the bonds will sell for above face value also known as a premium.

That lowers the yield on the bond, since the government only pays back the face value plus the stated interest. (If there’s lower demand, then the bonds may sell for below face value, which increases the yield.)

When Treasury yields rise, interest rates on business and personal loans generally rise too. That’s because investors know they can make a set yield on government issued products, so other investment products have to offer a better return in order to be competitive. This affects the market in that it affects the rates on mortgages, loans, and in turn, market growth.

There isn’t a set market yield, since the yield on each stock and bond varies. But there is a yield curve that investors track, which is a good reference. The yield curve plots Treasury yields across maturities—i.e., how long it takes for a bond to mature. Typically, the curve plots upward, since it takes more of a yield to convince an investor to hold a bond for a longer amount of time.

An inverted yield curve can be a sign of an oncoming recession and can cause concern among investors. While you don’t necessarily need to track 10-year Treasury yields or worry about the yield curve, it is good to know what the general yield meaning is for investors so you can stay informed about your investments.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

The Takeaway

A high yield means more cash flow and a higher income. But a yield that is too high isn’t necessarily a good thing. It could mean the market value of the investment is going down or that dividends being paid out are too high for the company’s earnings.

Of course, yield isn’t the only thing you’re probably looking for in your investments. Even when investing in the stock market, you may want to consider other aspects of the stocks you’re choosing: the history of the company’s growth and dividends paid out, potential for future growth or profit, the ratio of profit to dividend paid out. You may also want a diversified portfolio made up of different kinds of assets to balance return and risk.

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Oct

2023

What Is a Closed-End Fund?

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Closed-end funds, or CEFs, are a lesser-known type of investment fund that may benefit income investors who are looking to build a portfolio that provides both diversification and passive income. Similar to other funds such as index funds, mutual funds and exchange-traded funds (ETFs), CEFs pool together funds to purchase a basket of different types of assets, including stocks, bonds, and more.

By investing in them individuals gain exposure to a variety of investments through a single portfolio asset. Many retirees’ investment strategies include CEFs because of their high yields.

What Makes CEFs Unique?

The main difference between CEFs and other funds is that they are “closed,” meaning that investors can’t buy into them at any time they want. Instead, CEFs hold an initial public offering (IPO), similar to a stock IPO, when investors can buy into them and then close sales once the offering ends.

It’s useful to evaluate CEFs based on their Net Asset Value (NAV), which is the sum of the assets in the fund’s portfolio. Brokerage firms post CEF Net asset values on a daily basis. The NAV differs from the CEF’s market price. CEF shares may sell for a discount to their market value, making it beneficial to buy them through the market rather than in their initial offering.

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CEFs vs ETFs: How They Compare

CEFs and ETFs (which have their own pros and cons) have some obvious similarities, and some key differences that investors should be aware of.

CEF and ETF Similarities

• Trade on exchanges during daily trading hours like stocks

• Fund portfolios can be leveraged

• Can offer capital gains and distributions to investors

• Have fee schedules and expense ratios

• Hold portfolios of investments that have a total value

• Investors can trade shares like stocks using margins, shorting, and limit orders

• Can focus on specific sectors or broad indexes

CEF and ETF Differences

• ETFs usually track the performance of an index, whereas CEFs are actively managed

• Investors are more likely to pay capital gains with CEFs than with ETFs

• ETFs can’t issue debt or preferred shares, while CEFs can use these tools to create leverage

• ETFs have features that ensure their share price doesn’t differ very much from their net asset value. In contrast, it’s common for a CEF’s net asset value and share price to be different.

Recommended: ETFs vs Index Funds

CEFs vs Mutual Funds: What’s the Difference?

Like CEFs vs ETFs, CEFs and mutual funds have similarities and differences, too.

CEF and Mutual Fund Similarities

• Can pay out income and capital gains distributions to investors

• Run by professional management teams

• Have fee schedules and expense ratios

• Have a net asset value and contain multiple investments

CEF and Mutual Fund Differences

• Mutual funds issue and redeem shares daily, whereas CEFs trade on exchanges

• CEFs can issue debt and preferred shares in order to leverage their net assets, which can increase the amount of their distributions as well as the fund’s volatility

Recommended: Mutual Funds vs ETFs

Types of CEFs

Like other types of funds, every CEF has a different investment strategy and asset size. Funds may hold millions of dollars in assets or billions. Each has its advantages and downsides.

The main issue with small CEFs is they generally don’t trade at high volumes. That means that if an investor holds a large position they can actually affect the price when they buy or sell.

CEF Distributions

CCEFs pay out distributions on a regular basis. These are similar to dividend payments but have some key differences.

Since CEFs include both stocks and bonds, distributions can include bond interest payments, equity dividends, return of capital, and realized capital gains. The tax on the investment income from those earnings may differ between funds since they each have a different asset makeup.

CEF distributions can change over time, so a fund that has a very high payout may make cuts to it. So while an investor may choose a CEF with a high yield, it’s important to keep in mind that it could change over time.

One way to find a fund with an ideal yield is using the distribution-to-NAV ratio. CEFs are actively managed, and the managers need to earn money in order to pay out distributions. So by looking at the net asset value of the CEF compared to its distributions, investors can see whether a CEF will be able to maintain its current yield rate. If the NAV isn’t high enough to maintain a high distribution, the manager may cut the distributions.

One main benefit of CEFs is since they are actively managed, the managers can redistribute investments to maximize returns. However, like any asset, CEFs don’t always perform well. Some CEFs focus on a particular industry, and if that industry isn’t doing well the CEF may not perform well either. The success of a CEF also depends on the management team.

Recommended: How Often Are Dividends Paid?

How to Buy and Sell CEFs

It’s simple to buy and sell CEFs on major stock exchanges, and both beginning investors and those with more experience can participate in the CEF market. Investors can trade them during regular trading hours just like ETFs and stocks, although there are far fewer CEFs available on the market and they have much smaller trading volumes.

CEF Fees

One major downside of investing in CEFs is the high fees. Annual CEF fees tend to top 2%. However, the fees are taken out of the fund so investors may not notice them immediately. Proponents of CEFs claim that they have high fees because they have high quality managers who help the fund earn more money.

Fees can also include the cost of leverage, which is a tool CEFs use to make the fund more profitable. CEFs have more borrowing ability than individuals, so they can greatly benefit from using leverage, making the high fees worth it for investors. Of course, using leverage for investing also brings on additional risk.

It’s important for investors to consider whether paying high fees is worth it based on the performance of any particular CEF.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

The Takeaway

CEFs are a type of investment fund that typically offers diversification and passive income. CEFs have several similarities to exchange-traded funds and mutual funds, but they are closed investments that typically have higher fees and smaller trading volumes.

CEFs are also unique in that they have IPO-like market debuts. In effect, CEFs are something special on the market, and may be attractive to investors for a number of reasons. However, investors would do well to do their homework before investing – as always.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

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Oct

2023

Are Mutual Funds Good for Retirement?

By Rebecca Lake | invest, Investing, Preparing for Retirement | Comments Off

Mutual funds are one option investors may consider when building a retirement portfolio. A mutual fund represents a pooled investment that can hold a variety of different securities, including stocks and bonds. There are different types of mutual funds investors may choose from, including index funds, target date funds, and exchange-traded funds (ETFs).

But how do mutual funds work? Are mutual funds good for retirement or are there drawbacks to investing in them? What should be considered when choosing mutual funds for retirement planning?

Those are all important questions to ask when determining the best ways to build wealth for the long term.

Understanding Mutual Funds

A mutual fund pools money from multiple investors, then uses those funds to invest in a number of various securities. Mutual funds can hold stocks, bonds, short-term debt, and other types of securities.

How a mutual fund is classified or categorized can depend largely on what the fund invests in and what type of investment strategy it follows. For example, index funds follow a passive investment strategy, as these funds attempt to mimic the performance of a stock market benchmark. So a fund that tracks the S&P 500 index would attempt to replicate the returns of the companies included in that index.

Target-date funds utilize a different strategy. These funds automatically adjust their asset allocation based on a target retirement date. So a 2050 target-date fund, for example, may shift more of its asset allocation toward bonds or fixed-income and away from stocks as the year 2050 approaches.

Exchange-traded funds or ETFs trade on an exchange just like stocks. This is a departure from the way mutual funds are typically traded, with the price being set at the end of the trading day.

How Mutual Funds Work

Mutual funds work by allowing investors to purchase shares in the fund. Buying shares makes them part-owner of the fund and its underlying assets. As such, investors have the right to share in the profits of the fund. So if a mutual fund owns dividend-paying stocks, for example, any dividends received would be passed along to the fund’s investors.

Depending on how the fund is structured or what the brokerage selling the fund offers, investors may be able to receive any dividends or interest as cash payments or they may be able to reinvest them. With a dividend reinvestment plan or DRIP, investors can use dividends to purchase additional shares of stock, often bypassing brokerage commission fees in the process.

Investors pay an expense ratio to invest in mutual funds. This reflects the annual cost of owning the fund, expressed as a percentage. Passively managed mutual funds, including index funds and target date funds, tend to have lower expense ratios. Actively managed funds, on the other hand, tend to be more expensive, but the idea is that higher fees may seem justified if the fund produces above-average returns.

Investors can learn more about how a particular mutual fund works, what it invests in, and the fees involved by reading the fund’s prospectus.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Mutual Funds for Retirement Planning

Mutual funds are arguably one of the most popular investment options for retirement planning. According to the Investment Company Institute, 52.3% of U.S. households totaling approximately 115.3 million individual investors owned mutual funds in 2022. Older generations such as Baby Boomers and Gen Xers—those who may be planning for retirement—are more likely to have mutual funds, the research found.

So are mutual funds good for retirement? Here are some of the pros and cons to consider.

Pros of Using Mutual Funds for Retirement

Investing in mutual funds for retirement planning could be attractive for investors who want:

• Convenience

• Simplified diversification

• Professional management

• Reinvestment of dividends

Investing in a mutual fund can offer exposure to a wide range of securities, which can help with diversifying a portfolio. And it may be easier and less costly to purchase a single fund that holds 10 or 20 stocks than to purchase individual shares of each of those companies.

Mutual funds are professionally managed, so investors can rely on the fund manager’s expertise and knowledge. You don’t need to be as hands-on as you would need to be if you were day trading individual stocks. And if the fund includes dividend reinvestment, you can increase your holdings automatically which can make it easier to grow wealth.

Cons of Using Mutual Funds for Retirement

While there are some advantages to using mutual funds for retirement planning, there are also some possible disadvantages, including:

• Potential for high fees

• Overweighting risk

• Under-performance

• Tax inefficiency

As mentioned, mutual funds and ETFs carry expense ratios. While some index funds may charge as little as 0.15% in fees, there are some actively managed funds with expense ratios well above 1%. If those higher fees are not being offset by higher than expected returns (which is never a guarantee), the fund may not be worth it. Likewise, buying and selling mutual fund shares could get expensive if your brokerage charges steep trading fees.

While mutual funds make it easier to diversify, there’s the risk of overweighting one’s portfolio — owning the same holdings across different funds. For example, if you’re invested in five mutual funds that hold the same stock and the stock tanks, that could drag down your portfolio.

Something else to keep in mind is that a mutual fund is typically only as good as the fund manager behind it. Even the best fund managers don’t always get it right. So it’s possible that a fund’s returns may not live up to your expectations.

On the other hand, you may also have to contend with unexpected tax liability at the end of the year if the fund sells securities at a gain. Just like other investments, mutual funds and ETFs are subject to capital gains tax. Whether you pay short- or long-term capital gains tax rates depends on how long you held a fund before selling it.

Pros	Cons
• Mutual funds offer convenience for investors • It may be easier and more cost-effective to diversify using mutual funds vs. individual securities • Investors benefit from the fund manager’s experience and knowledge • Dividend reinvestment can make it easier to grow wealth	• Some mutual funds may carry higher expense ratios than others • Overweighting can occur if investors own multiple funds with the same underlying assets • Fund performance may not always live up to the investor or fund manager’s expectations • Income distributions can result in unexpected tax liability for investors

Pros

Cons

• Mutual funds offer convenience for investors

• It may be easier and more cost-effective to diversify using mutual funds vs. individual securities

• Investors benefit from the fund manager’s experience and knowledge

• Dividend reinvestment can make it easier to grow wealth

• Some mutual funds may carry higher expense ratios than others

• Overweighting can occur if investors own multiple funds with the same underlying assets

• Fund performance may not always live up to the investor or fund manager’s expectations

• Income distributions can result in unexpected tax liability for investors

Investing in Mutual Funds for Retirement Planning

The steps to invest in mutual funds for retirement are simple and straightforward.

1. Start with an online brokerage account, individual retirement account (IRA) or 401(k). You can also buy a mutual fund directly from the company that created it, but a brokerage account or retirement account is usually the easier way to go.

2. Set your budget. Decide how much money you can afford to invest in mutual funds. Keep in mind that the minimum investment for a particular fund can vary. One fund may allow you to invest with as little as $100 while another might require $1,000 to $3,000 to get started.

3. Choose funds. If you already have a brokerage account, this may simply mean logging in, navigating to the section designated for buying funds, selecting the fund or funds and entering in the amount you want to invest.

4. Submit your order. You may be asked to consent to electronic delivery of the fund’s prospectus when you place your order. If your brokerage charges a fee to purchase mutual funds, that amount will likely be added to the order total. Once you submit your order to purchase mutual funds, it can take a few business days to process.

Determining If Mutual Funds Are Right for You

Whether it makes sense to invest in mutual funds for retirement can depend on your time horizon, risk tolerance, and overall investment goals. If you’re leaning toward mutual funds for retirement planning, here are a few things to consider.

Investment Strategy

When comparing mutual funds, it’s important to understand the overall strategy the fund follows. Whether a fund is actively or passively managed may influence the level of returns generated. The fund’s investment strategy may also determine what level of risk investors are exposed to.

For example, index funds are designed to meet the market. Growth funds, on the other hand, typically have a goal of beating the market. Between the two, growth funds may produce higher returns — but they may also entail more risk for the investor and carry higher expense ratios.

Choosing funds that align with your preferred strategy, risk tolerance, and goals matters. Otherwise, you may be disappointed by your returns or be exposed to more risk than you’re comfortable with.

Cost

Cost is an important consideration when choosing mutual funds for one reason: Higher expense ratios can drain away more of your returns.

When comparing mutual fund expense ratios, it’s important to look at the amount you’ll pay to own the fund each year. But it’s also important to consider what kind of returns the fund has produced historically. A low-fee fund may look like a bargain but if it generates low returns then the cost savings may not be worth much.

It’s possible, however, to find plenty of low-cost index funds that produce solid returns year over year. Likewise, you shouldn’t assume that a fund with a higher expense ratio is guaranteed to outperform a less expensive one.

Fund Holdings

It’s critical to look under the hood, so to speak, to understand what a particular mutual fund owns and how often those assets turn over. This can help you to avoid overweighting your portfolio toward any one stock or sector.

Reading through the prospectus or looking up a stock’s profile online can help you to understand:

• What individual securities a mutual fund owns

• Asset allocation for each security in the fund

• How often securities are bought and sold

If you’re interested in tech stocks, for example, you may want to avoid buying two funds that each have 10% of assets tied up in the same company. Or you may want to choose a fund that has a lower turnover rate to minimize your capital gains tax liability for the year.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

Other Types of Funds for Retirement

Mutual funds, and target date funds in particular, are one of the ways to save for retirement. But there are other options you might consider. Here’s a brief rundown of other types of funds that can be used for retirement planning.

Real Estate Investment Trusts (REITs)

A real estate investment trust isn’t a mutual fund, per se. But it is a pooled investment that allows multiple investors to own a share in real estate. REITs pay out 90% of their income to investors as dividends. You may consider a REIT if you’d like to reap the benefits of real estate investing (i.e. diversification, inflationary hedge, etc.) without actually owning property.

Exchange-Traded Funds (ETFs)

Exchange-traded funds are another retirement savings option. Investing in ETFs can offer more flexibility compared to mutual funds. They may carry lower expense ratios than traditional funds and be more tax-efficient if they follow a passive investment strategy.

Income Funds

An income fund is a specific type of mutual fund that focuses on generating income for investors. This income can take the form of interest or dividend payments. Income funds can be an attractive option for retirement planning if you’re interested in creating multiple income streams or reinvesting dividends until you’re ready to retire.

Bond Funds

Bond funds focus exclusively on bond holdings. The type of bonds the fund holds can depend on its objective or strategy. For example, you may find bond funds or bond ETFs that only hold corporate bonds or municipal bonds while others offer a mix of different bond types. Bond funds are generally considered fairly safe, and they may help round out the fixed-income portion of your retirement portfolio.

IPO ETFs

An initial public offering or IPO represents the first time a company makes its shares available for trade on a public exchange. Investors can invest in individual IPOs or multiple IPOs through an ETF. IPO ETFs invest in companies that have recently gone public so they offer an opportunity to get in on the ground floor. IPO ETFs are generally considered safer than IPOs, but still, they are relatively risky.

The Takeaway

Mutual funds can be part of a diversified retirement planning strategy. Regardless of whether you choose to invest in mutual funds, ETFs or something else, the key is getting started sooner rather than later. Time can be one of your most valuable resources when investing for retirement.

Invest with as little as $5 with a SoFi Active Investing account.

Photo credit: iStock/kali9

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Oct

2023

Dogs of the Dow: Meaning, How It Works & Examples

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

What Are the Dogs of the Dow?

The “Dogs of the Dow” is an investment strategy that focuses on large, established companies that offer relatively high dividends. There are different ways to pursue the strategy, but it generally attempts to outperform the Dow Jones Industrial Average (DJIA) by investing in the highest dividend-yielding stocks from among the 30 stocks that comprise the DJIA.

The Dow Jones is among the oldest and most popular stock indices in the world, with casual investors often using it as a shorthand for the performance of the broader stock market, and even the global economy. Over time, the Dogs of the Dow tends to perform in line with it.

The Dogs of the Dow strategy became popular in 1991 with the publication of Beating the Dow in which author Michael B. O’Higgins coined the term “Dogs of the Dow.” The strategy itself reflects the assumption – usually true – that blue-chip companies have the stability to continue to pay out their regular dividends regardless of the performance of their stocks.

How the Dogs of the Dow Work

The formula for identifying the companies in the Dogs of the Dow is – by the standards of economics – fairly simple. It comes down to the stock’s dividend yield, calculated by dividing the annual dividend paid by a stock (in dollars) by its stock price. The stocks with the highest dividend yields are the Dogs of the Dow.

Followers of the Dogs of the Dow strategy believe the dividend paid by a company more accurately reflects its average value than the trading price of that company’s stock. Unlike the dividend, the stock price is always in flux.

When the stock prices of companies go down in response to the business cycle, the ratio of those companies’ dividends to their stock prices will go up. In other words, the dividends of those stocks will be disproportionately high in relation to their stock prices. Adherents of the Dogs of the Dow strategy believe the companies with that high dividend-to-stock-price ratio will eventually revert to their mean and should grow faster when the business cycle turns, and their prices increase. In addition to promising performance, the strategy also offers investors regular income in the form of dividend payments.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Who Are the Dogs of the Dow in 2023?

The 2023 Dogs of the Dow are led by Verizon with a dividend yield of 6.62%, followed by Dow with a dividend yield of 5.56%. The others are: Intel (5.52%), Walgreens (5.14%), 3M (4.97%), IBM (4.68%), Amgen (3.24%), Cisco (3.19%), Chevron (3.16%), and JP Morgan Chase (2.98%).

The Dogs are always changing, as are the companies that make up the DJIA itself. In 2020, for example, Salesforce.com joined the index – a rare entrant that has never paid its investors a dividend. In the same year, troubled aerospace titan and DJIA member Boeing suspended its dividend.

Between 2022 and 2023, Cisco and JP Morgan Chase joined the list, and Merck and Coca-Cola left the list because their dividend yields dropped.

It’s easy to see that the highest-yielding stocks in the DJIA are always changing. This means that an investor who is pursuing this strategy needs to regularly rebalance their holdings, whether monthly, quarterly or annually.

One reason such rebalancing is necessary is that even though the large stocks in the DJIA typically have lower volatility than some other stocks, their values still change over time. So rebalancing is an important step toward preventing a situation where one stock plays too big of a role in a portfolio’s performance. But with a Dogs of the Dow strategy, rebalancing is even more important, as the companies that fit the description will change on a semi-regular basis.

Investing in the Dogs of the Dow

Different investors view the Dogs of the Dow differently. Some say it’s only the five or 10 DJIA stocks with the highest dividend-to-share-price relationship. But it’s worth noting that not all 30 companies on the DJIA index currently pay dividends.

Investors can buy 10, 15 or all 30 of those stocks through a brokerage account. Or they can invest in the DJIA by purchasing exchange-traded funds (ETFs). There are even Dogs of the Dow ETFs that invest in the dividend-focused strategies similar to Dogs of the Dow approach. But when buying one of these funds, it is important to read their strategies before investing.

Recommended: What Are Dividend ETFs?

Pros and Cons of Dogs of the Dow Strategy

There are several advantages to using a Dogs of the Dow strategy, but there are also some drawbacks for investors to consider.

Dogs of the Dow: Pros

• The strategy invests in Blue Chip companies with a long history of success and industry-leading positions.

• It has a history of outperforming the DJIA.

• Investors receive regular dividend payments.

Dogs of the Dow: Cons

• The IRS taxes dividends paid by the stocks at the income-tax rate rather than the lower capital gains rate.

• It is a value-oriented strategy that may lag during growth markets.

• The strategy isn’t widely diversified.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

Does Dogs of the Dow Still Work?

The Dogs of the Dow struggled during the market upheaval of 2020. As a group of 10, the Dogs lost 13% over the course of the year, well below the 7% increase posted by the DJIA. In 2021, the Dogs were also below the DJIA and the S&P 500. And 2021 was the third straight year the Dogs didn’t do as well as the broader Dow.

However, in 2022, Dogs of the Dow did better than the DIJA with a positive return of 2.2%, while the DJIA had a negative return of -7.0.

Historically, Dogs of the Dow has occasionally done worse than the broader DJIA, notably in the financial crisis of 2008, when it suffered larger losses than the index. But through the 10 years that followed, it outperformed the Dow, though not profoundly.

But even small amounts of outperformance add up over time. A $10,000 investment in the DJIA made at the outset of 2008 would have grown to approximately $17,350 by the end of 2018. The same amount invested in the Dogs of the Dow strategy would have reached $21,420 by the end of 2018, assuming that the investor rebalanced their holdings once per year.

The Takeaway

Dogs of the Dow is an investment strategy that uses dividends as a way to spot undervalued Blue Chip stocks, and to benefit from economic cycles.

While investors may be interested in exploring the Dogs of the Dow, the strategy does have pros and cons. Investors should weigh the benefits and drawbacks carefully before using it.

Invest with as little as $5 with a SoFi Active Investing account.

Photo credit: iStock/Helin Loik-Tomson

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

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What Is the Yield Curve? How It’s Used as a Market Indicator

4 Types of Yield Curves and What They Mean

1. Normal Yield Curve

2. Steep Yield Curve

3. Inverted Yield Curve

4. Flat and Humped Yield Curves

What Is the Current Yield Curve?

How Investors Can Interpret the Yield Curve

The Takeaway

What Is Yield?

How Do You Calculate Yield?

Cost Yield vs. Current Yield

Rate of Return vs. Yield

Definition of Yield for Different Investments

Yield in Stock Investing

Yield in Bond Investing

Is There a Market Yield?

The Takeaway

What Is a Closed-End Fund?

What Makes CEFs Unique?

CEFs vs ETFs: How They Compare

CEF and ETF Similarities

CEF and ETF Differences

CEFs vs Mutual Funds: What’s the Difference?

CEF and Mutual Fund Similarities

CEF and Mutual Fund Differences

Types of CEFs

CEF Distributions

How to Buy and Sell CEFs

CEF Fees

The Takeaway

Are Mutual Funds Good for Retirement?

Understanding Mutual Funds

How Mutual Funds Work

Mutual Funds for Retirement Planning

Pros of Using Mutual Funds for Retirement

Cons of Using Mutual Funds for Retirement

Investing in Mutual Funds for Retirement Planning

Determining If Mutual Funds Are Right for You

Investment Strategy

Cost

Fund Holdings

Other Types of Funds for Retirement

Real Estate Investment Trusts (REITs)

Exchange-Traded Funds (ETFs)

Income Funds

Bond Funds

IPO ETFs

The Takeaway

Dogs of the Dow: Meaning, How It Works & Examples

What Are the Dogs of the Dow?

How the Dogs of the Dow Work

Who Are the Dogs of the Dow in 2023?

Investing in the Dogs of the Dow

Pros and Cons of Dogs of the Dow Strategy

Dogs of the Dow: Pros

Dogs of the Dow: Cons

Does Dogs of the Dow Still Work?

The Takeaway

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