Q: The Federal Reserve is expected to raise rates, and high-dividend stocks can be under pressure when rates rise. Should I wait until after the Fed's decision is announced before I buy any more dividend stocks?
Higher interest rates are generally bad news for dividend stocks. In fact, the pressure of rising rates is why the high-dividend REIT sector has been one of the market's worst performers over the past few years.
Here's why: As interest rates on risk-free investments such as Treasury bonds rise, investors expect yields from riskier investments like dividend stocks to rise accordingly.
However, there's one flaw with the logic that it's best to wait until after the next Fed rate hike before buying dividend stocks. Specifically, high-dividend stocks tend to take their cues from longer-term Treasury bonds, specifically the 10 year, which is not tied to the Federal Funds Rate.
Don't get me wrong -- long-term bond yields tend to go in the same direction as the Fed's moves, but it's not a perfect correlation and can be rather unpredictable. In fact, over the past three years, the Federal Funds Rate has increased by 175 basis points while the 10-year Treasury yield has increased by about half of that. Plus, there have been times when the 10-year yield dropped immediately after a rate hike.
The bottom line is that if you think the general direction of interest rates will be higher, holding off on dividend stocks makes sense. But don't expect dividend stocks to suddenly go on sale after the Fed (predictably) raises interest rates.