If it weren't for the monetary policy of the Federal Reserve
governors and Fed Chairman Ben Bernanke, there would be no
fiscal cliff
. Of that I'm convinced.
I say that because the Fed is the great enabler. It is the
proverbial drug pusher; the supplier of the "dope" - free money -
that allows the D.C. politicians to spend extravagantly, while
avoiding the consequences of their extravagance.
Their symbiotic relationship is as simple as it is
addicting.
The U.S. Treasury issues bonds, notes and bills to cover the
deficit between spending and taxes received. Thanks to the Feds
voracious appetite for these securities (the Fed bought nearly
70% of Treasury's debt this year), an artificial demand is
created, which lowers the required yield, and thus the Treasury's
borrowing costs. (In addition, all profits the Fed generates are
returned to the U.S. Treasury.)
While total government debt has ballooned in recent years to
nearly 100% of gross domestic product (
GDP
), the annual interest paid by the government on the debt has
remained constant. Interest payments remain manageable
because of falling interest rates. In 2001, the federal
government paid an average of 6.2% on its debt. The average rate
today is around 2%.
This is a useful alchemy for a free-spending Congress: jack up
the debt level but not the annual interest paid on the
debt.
The politicians, in turn, can continue spending and avoiding
the hard choices the fiscal cliff demands. Instead of lowering
the heightened level of uncertainty that plagues financial
markets, the politicians can prolong it by continually raising
the debt ceiling.
In the meantime, business continues to languish. U.S.
companies sit on record levels of cash (approximately $2
trillion). They are unsure what markets to pursue or where to
invest because they are unsure how any eventual compromise on the
fiscal cliff will impact their plans.
This stockpiling of cash is a drag on the economy, because
cash does not earn a real risk-adjusted return. Investment fuels
economic growth, not cash.
The Fed's monetary policies have produced a nightmare
situation for income investors: The 10-year Treasury note yields
1.7%, a high-grade municipal bond yields 1.5%, one-year
certificates of deposit yields less than 1% and pass-book savings
and Treasury bills yield a few basis points.
None of these investments provide a positive real rate of
return when taking inflation into account.
In desperation, many investors have turned to
Treasury Inflation-Protected Securities
(
TIPS
), believing these investments will protect their income against
inflation and interest-rate risk.
Unfortunately, they're wrong. Investors have been fooled into
believing TIPS will help maintain purchasing power. TIPS won't,
because they have been manipulated to understate inflation. The
Fed also buys TIPS and, thereby distorting the important
inflation gauges in the market.
In the search for yield and income, many investors have
doubled down by seeking out longer-maturity and riskier bonds.
This is a dangerous strategy, because the longer the average
maturity of a bond portfolio, the greater the interest-rate risk
(i.e., the risk that the bonds fall in value as interest rates
rise).
We need only look back to earlier this year when a few
encouraging economic indicators persuaded investors that the
economic recovery was finally under way. That wasn't the case,
and the bond market sold off sharply. Many investors suffered
significant losses.
Many bond investments are high-risk investments, which is why
savvier investors are turning to dividend-paying stocks for
income, yield and purchasing-power protection.
This makes sense:
Dividend-growth stocks
- stocks that increase their payouts - will help maintain
purchasing power in the face of inflation. There are
other avenues as well.
Many higher-yield master limited partnerships (MLPs) provide
reliable tax-efficient income. This is an important
consideration given the impending
dividend-tax increase
baked into the fiscal cliff. Payouts on many of these
partnerships won't be materially impacted by higher
dividend-tax rates.
Higher-yield foreign dividend stocks also enhance income
while concurrently reducing portfolio risk. Foreign stocks tend
to have lower correlations with their domestic counterparts. In
addition, these stocks are frequently paid in a currency that
moves inversely to the U.S. dollar.
In short, this dividend-strategy is the strategy of the
High Yield Wealth
portfolio, which is composed of a diverse mix of quality
dividend-growth stocks, high-yield MLPs, income-generating
foreign stocks and variable-rate debt.
I'm convinced that the
High Yield Wealth
strategy is the best strategy for maintaining wealth and
purchasing power in today's
range-bound
, low-rate and highly uncertain market.
What's more, when (or should I say "if") Congress and the
Fed come to their senses, the
High Yield Wealth
strategy will continue to maintain its wealth-accumulating
appeal.
Editor's note: If you'd like to learn more about how to
profit from the
Fiscal Cliff
without lots of risk, then you should read more about 3
simple tax-advantaged dividend stocks we've uncovered. It's a
simple premise: if taxes go up on dividends, you want to own
these types of specialized dividend payers that can legally
shelter income and avoid any new tax increases.
Click here
to get the full story.