Maximizing returns in a high interest rate environment 

27 October 2023
Maximizing returns in a high interest rate environment
  • With interest rates going up and the possibility of a recession looming, it makes sense to prioritize maximizing investment yield potential over valuation growth over the next year or two.
  • The S&P 500 has provided an average annual return of 8.14% over the past two decades (2002-2022). However, with interest rates where they are, you can already secure over half of that return through relatively low-risk investment options.
  • Traditional dividend stocks, which were once a go-to for investors, are now facing competition from alternative avenues offering higher yields. 

As interest rates are anticipated to rise (or at least remain at the current high levels) in the US and Europe, knowing where to get the best yield on your investments becomes even more important. Since another economic downturn is not excluded, prioritizing investment yield potential over capital growth is a prudent call. Here, we’ve compiled a list of nine investment options to cater to a wide range of investors.

High-Interest Savings Account

  1. Offers slightly higher interest rates than regular savings accounts.
  2. Typically requires a relatively high minimum deposit and notice period.
  3. May limit the number of withdrawals or transfers.
  4. Provides a short-term, low-risk option.

Average Yields: Up to 5.05% in the US and up to 4.45% in the UK.

Risk Level: 1/10

What to be conscious of: these yields vary considerably, so you’ll need to sniff around for a good rate. Bank deposits are usually insured up to a certain amount, depending on your jurisdiction.

Fixed Deposits

  1. Similar to savings deposits but with a fixed term and guaranteed interest rates.
  2. Longer fixed terms often result in higher interest rates.
  3. Interest rates are influenced by central bank policies.

Average Yields: 5.5% in the US and UK for a 12-to-24-month fixed rate.

Risk Level: 2/10

What to be conscious of: your rates are dependent on central bank policy moves. If you think central banks are going to cut rates, you might consider a longer-term fixed deposit to lock in today’s higher interest rates.

Money-Market Funds (MMFs)

  1. Invest in low-risk, short-term debt from reputable sources.
  2. Managed by financial institutions.
  3. Not insured by the Federal Deposit Insurance Corporation (FDIC) in the US.

Average Yields: 4.88% in the US.

Risk Level: 3/10

What to be conscious of: unlike deposits, MMFs aren’t insured by the Federal Deposit Insurance Corporation (FDIC) in the US, so this is not a guaranteed investment. The value of your MMF can rise or fall, so you could lose more than you invested, although the historical risk of that is low.

Covered Call ETFs

  1. Employ option strategies to generate higher yields.
  2. Sell call options on the underlying stock position.
  3. Provide extra income but come with a cap on potential profit.

Average Yields: 10.5% to 11.5%.

Risk Level: 4/10

Examples: The Global X S&P 500 Covered Call ETF (ticker: XYLD; expense ratio: 0.6%), the Global X Russell 2000 Covered Call ETF (RYLD; 0.6%), or the JPMorgan Equity Premium Income ETF (JEPI; 0.35%).

What to be conscious of: These funds can provide higher yields, lower your portfolio volatility, and give you strategic flexibility, but they come with a cap on your potential profit. They also work best in a “sideways-moving” market with high volatility. There are many types of covered call ETFs you can invest in because calls can be bought and sold on almost any index, sector, or stock.

Real Estate Investment Trusts (REITs)

  1. Structured like mutual funds with the majority of assets invested in real estate.
  2. Offer yields between 4% and 5%.
  3. Focus on income rather than capital appreciation.

Average Yields: Vary but can go as high as 14% for certain REITs.

Risk Level: 4.5/10

Examples: The VanEck Mortgage REIT Income ETF (MORT; 0.41%), the iShares Mortgage Real Estate ETF (REM; 0.48%), and the iShares European Property Yield UCITS ETF (IPRP; 0.4%).

What to be conscious of: Unlike purchasing actual real estate, with REITS, you get little in the way of capital appreciation. That’s because they’re mandated to pay 90% of their income back to investors and reinvest only 10% back into new holdings.

Traditional Dividend Stocks or ETFs

  1. Stocks that generate strong cash flows often return cash to shareholders regularly. 
  2. Stable high-dividend-yielding stocks are more common in mature, slow-growing, low-volatility industries like utilities, telecommunications, energy, and consumer staples.

Average yields: The energy and real estate sectors in the US are two of the highest-yielding ones (in the US) and have a trailing 12-month dividend yield of 3.96% and 3.42%, respectively.

Risk level: 5/10

Examples: The Franklin International Low Volatility High Dividend Index ETF (LVHI; 0.4%), the WisdomTree International Hedged Quality Dividend Growth Fund (IHDG; 0.58%), the iShares Euro Dividend UCITS ETF (IDVY; 0.4%), and the Xtrackers EURO STOXX Quality Dividend UCITS ETF (XD3E; 0.3%).

What to be conscious of: Companies can cut their dividends, so rather than buying individual high-dividend stocks, you can buy dividend ETFs instead. Unlike high-yield deposits or MMFs, you get to participate in the potential share price appreciation (or depreciation) of the stocks.

High-Yield Bond ETFs

  1. Bonds offer regular income streams but are sensitive to interest rate changes.
  2. High-yield bonds, or “junk” bonds, come with higher yields.

Average yields: Some high-yield bond ETFs offer yields as high as 11.5% (average 5% to 6%)

Risk Level: 8/10 (varies by bond ETF)

Examples: The BlackRock Floating Rate Loan ETF (BRLN; 0.55%), the iShares € High Yield Corp Bond UCITS ETF (IHYG; 0.5%), and the iShares $ High Yield Corp Bond ESG UCITS ETF (DHYG; 0.27%).

What to be conscious of: High-yield bond ETFs are sensitive to changes in interest rates. When interest rates rise, bond prices typically fall, which can result in a decline in the value of the ETF. Furthermore, high interest rates can threaten the solvency of many companies with poor credit ratings. You need to have an opinion on where interest rates will go from here.

Rental Properties

  1. Invest in real estate and generate passive income through renting.
  2. It’s generally considered a very effective inflation hedge

Average yields: 5% to 6% in the US and UK, but they highly depend on property type and locations. Substantial research and property management are part of the game.

Risk Level: 3/10

What to be conscious of: Compared to other investment options, you’ll likely need to spend a lot more time and effort researching what and where to buy. There are several transaction costs involved (mortgage costs, legal fees, and property management charges). Depending on where you’re based, tax rules may be more or less punitive on your net returns. Also, since yields vary so widely across cities, even within a single country, you’ll really need to do your homework before you invest.

Property Crowdfunding

  1. Access to real estate investments, either crowdfunding a property or even investing in loans to real-estate developers without a large upfront investment.
  2. Involves low liquidity and higher transaction costs.

Average yields: Offers variable yields, typically ranging from 4% to 16%.

Risk Level: 9/10

Examples: Fundrise, Yieldstreet, Estate Guru, Rendity, Shojin Property Partners, CapitalRise.

What to be conscious of: Liquidity is low because there’s usually a minimum lock-in period for your investment that can range from one to four years. These investments have attractive yields, but they also come with higher transaction costs. And because they’re classified as high-risk investments, you may need to earn above a certain amount or have a minimum amount of assets to invest (i.e. you may need to be an “accredited investor”).

Conclusions

Interest rates move, so the yields from these ten investment options are probably going to change. But many of these options have a low correlation to the market – meaning, they won’t necessarily fall if stocks fall – and that can help diversify your portfolio, better insulating you against a possible recession.

Ultimately, the options you choose will depend on your risk tolerance, your investment horizon, your view on future interest rates, and your overall preference for yield or price appreciation. And don’t forget that taxes can have a big impact on your final return, and these vary depending on where you are and where you invest.

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