Are you looking for above-average investment income, but don't have a ton of idle cash to work with? It's a tall order to be sure. See, investing is ultimately about trade-offs. Reliable dividend-paying stocks generally don't sport sky-high yields, for instance, just as growth stocks generally don't pay significant dividends.
If you look far off the beaten path, though, you'll find sizable, reliable dividend yields you can count on.
Take AGNC Investment (AGNC +2.18%) as an example. This mortgage REIT (real estate investment trust) is yielding an incredible 16.1% right now. A mere $6,500 investment in this ticker would generate $1,000 worth of annual dividend income, presuming the dividend payments that it's dished out for nearly four straight years will persist into the future. Better still, these dividends are paid out on a monthly rather than a quarterly basis. That's convenient if your plan is to use this income to help pay your monthly bills.
But first things first. What the heck is a mortgage REIT?
Mortgage REITs explained
Most readers of this article are likely familiar with stocks of for-profit companies like Apple, Microsoft, and retailer Walmart. Real estate investment trusts, or REITs, are different. Although investors buy and sell shares of REITs just like they buy and sell conventional stocks, REITs are actually stakes in rental real estate enterprises. Most of the profits earned by hotel, apartment, retail, or office REITs are passed back to the REIT's shareholders in the form of dividends.
Mortgage REITs are distinctly different even by REIT standards. This type of real estate investment trust doesn't own any actual real estate, but rather, it owns bundles of mortgage loans. Such REITs make their money by borrowing funds at a lower cost than the interest rates being paid on the loans they buy. If it sounds a little bit like interest rate arbitrage, that's because it is.
Multiple vehicles can be used to execute such a strategy. AGNC Investment's preferred vehicle is government-backed mortgage securities (from lending agencies like Fannie Mae, Freddie Mac, and Ginnie Mae). It owns more than $50 billion worth of these bond-like securities right now, collectively paying the REIT more in interest payments than AGNC Investment is paying to borrow capital itself; the average spread between these two figures right now is roughly 3 percentage points.
This business model isn't without its risks. Chief among them is rapid changes in prevailing interest rates. If interest rates move in one direction too far too fast -- as has been the case since early 2022 -- a REIT's managers can't always keep up. The so-called yield curve's inversion seen back in 2019 also works against mortgage REITs, by driving their short-term borrowing costs above the interest rates on the longer-term loans they're buying. The combination of these headwinds is a big reason AGNC Investment lowered its dividend back in 2019 and again in 2020, and why the REIT's shares have underperformed since then.
NASDAQ: AGNC
Key Data Points
The thing is, the dividend is still being paid like clockwork. The interest rate factors working against mortgage REITs since then are also starting to abate. Better days may be on the offing, possibly including higher dividends.
Better days ahead
The U.S. yield curve is still inverted, by the way. In fact, the negative spread between yields on 10-year Treasuries and two-year Treasuries reached a multi-decade low in June and remains negative even if the gap has narrowed a bit in the meantime.
The funny thing is, the recession the inverted yield curve was supposed to signal back in 2019 and certainly by mid-2022 has yet to materialize. It's increasingly looking like the market feared and priced in a recession that just wasn't in the cards. As the so-called "soft landing" scenario looks more and more likely, don't be surprised to see the yield curve continue un-inverting. This of course works back in favor of AGNC Investment's business model, which as was noted involves short-term borrowings to buy longer-term mortgage-backed securities.
And it would be a much-welcomed development.
See, while AGNC is still paying its monthly dividend, the operation slipped into the red in the past couple of quarters. It can handle making payments while in the red for a while. But it's not a sustainable long-term option.
The yield curve's current trajectory toward de-inversion, however, means AGNC Investment's real bottom line will eventually recover. And the Federal Reserve's expectations for slight, steady declines in interest rates through 2026 make it more likely the U.S. yield curve will revert back to normal (where longer-term rates are higher than short-term interest rates) sooner than later.
10-2 Year Treasury Yield Spread data by YCharts
Maybe most important is that the avoidance of a recession and the rekindling of economic growth founded on a renormalized interest rate yield curve also sets the stage for more of the high-quality mortgage lending that AGNC relies on.
On balance, AGNC Investment is a buy for income seekers
Never say never. It's possible all interest rates will linger at levels that are disadvantageous to mortgage REITs like AGNC Investment. Perhaps the economy will remain so lethargic that the mortgage-lending market dries up even more than it already has.
As an investor, though, it's often too easy to become so fearful of what might happen that you can't see what's more likely to happen, or is happening. The market is pricing in a worst-case scenario for this particular mortgage REIT that arguably should have already taken shape if it was ever going to. And AGNC Investment continues to make its monthly dividend payments in the meantime, rewarding patient shareholders who can stomach the volatility.
Bottom line: AGNC's not well suited to be a core holding for anyone's portfolio, even investors prioritizing income. It's a volatile stock, and tough to hold on to even if the future volatility is apt to be net-bullish. With a yield of more than 16% based on a dividend that's been pretty darn resilient even in a challenging environment, however, you could certainly do a lot worse than AGNC.
