While the onset of deflation is making cash balances seem a lot more desirable, a low interest rate means that the return on savings is very poor. Certainly, 1 today will buy less than it will do next month, since prices are falling, but a pretax return of 2% per annum still seems rather paltry when you could be receiving over 4% through a number of high quality blue-chips.
Risk
Of course, investing is riskier than holding cash in terms of there being the potential for you to get back less than you invest. However, in the long run, the risk of inflation eroding the value of your cash balance (in real terms) is equally grave. And, while deflation is present right now, the sheer volume of quantitative easing and the length of time at which interest rates have been at historic lows means that, over the medium to long term, it is relatively likely that inflation will become a cause for concern.
Financial Standing
One way to manage the risk from investing in high-yield shares is to focus on their financial standing. For example, Vodafone (LSE: VOD) (NASDAQ: VOD.US) is a very robust, well-diversified and financially sound business and, in the long run, the potential loss in value of an investment in the company is unlikely to be particularly high. For example, Vodafone operates in a number of different territories, thereby offering regional diversification, and is also expanding into new product lines, such as broadband and pay-tv. Furthermore, Vodafones balance sheet remains only moderately leveraged and this means that its risk is reduced further.
Defensive Business
Similarly, buying shares in defensive stocks such as domestic energy supplier, SSE (LSE: SSE) (NASDAQOTH: SSEZY.US) may also be a sensible move. Unlike the vast majority of companies in the FTSE 100, its financial performance is not closely linked to the performance of the wider economy and, in fact, should the economy go through a mild downturn or period of uncertainty, investor sentiment in defensive stocks can increase. And, with SSE having a beta of 0.8, its shares should offer less volatility than the wider index over the medium to long term, too.
Special Dividends
As well as seeking out stocks that offer high headline yields, special dividends can also make a real difference to your income returns in the medium to long term. One company that is planning on returning a significant amount of cash over the next handful of years is house builder, Persimmon (LSE: PSN). Between now and 2021, Persimmon plans to return at least 380p per share to its investors in the form of special dividends. This works out as 19% of Persimmons current share price and could be much more if the favourable trading conditions currently being experienced by the house building sector continue.
Looking Ahead
So, while the risk of investing may seem higher than having cash sat in a savings account, the risk of doing nothing could be even greater in the long run. And, with Vodafone, SSE and Persimmon offering yields of 4.6%, 5.4% and 5% respectively, they remain hugely appealing as income stocks at the present time.
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Peter Stephens owns shares of SSE and Persimmon.
