DIV 302Lesson 6 of 60 of 6
Interest Rates and Dividend Investing
Why dividend stocks move with bond yields, and which ones move the most.
What you’ll learn
- Why dividend stocks often move opposite to interest rates
- Which income investments feel rate changes the most
- Why BDCs tend to benefit from higher rates while REITs suffer
- How to think about rates without trying to predict them
In 2022, the Federal Reserve raised interest rates faster than at any time in forty years. Many dividend stocks that had felt rock solid fell sharply, REITs lost about a quarter of their value, and investors who had treated high yield stocks as bond substitutes discovered they behaved a lot like bonds too. Interest rates are the gravity of the income world. Here’s how they pull on your investments.
Why rates pull on dividend stocks
Imagine safe Treasury bonds pay 1%. A utility paying 4% looks generous, and investors bid its price up. Now Treasuries pay 5%. Why take stock market risk for 4%? Investors sell until the utility’s yield rises to, say, 6%, enough extra to justify the risk. Its dividend never changed; its price fell.
That’s the core relationship. The steadier and slower growing a stock’s dividend, the more it behaves like a bond, and the more rates move it. Try it:
Who feels it most
| Investment | Effect of rising rates | Why |
|---|---|---|
| REITs | Usually hurt, often badly | Heavy borrowing, bond-like valuations, harder to grow by raising money |
| Utilities | Usually hurt | Heavy borrowing; slow growth makes them bond substitutes |
| Telecoms, consumer staples | Often hurt | Steady, slow growing dividends valued like bonds |
| Preferred stocks | Hurt | Fixed payments, like long bonds |
| Mortgage REITs | Hurt when rates jump, can benefit later | Funding costs rise and bond values fall quickly |
| BDCs | Usually helped, at first | Floating rate loans earn more; risk rises if borrowers struggle |
| Banks | Mixed | Earn more on loans, but deposits get pricier and bond holdings lose value |
| Dividend growth stocks | Less affected | Growing payouts offset the pull of higher rates over time |
2022, the textbook case
As rates jumped in 2022, REIT funds such as VNQ fell roughly a quarter, preferred stock funds fell sharply, and long-term bonds had one of their worst years on record. Meanwhile BDCs saw their income rise, and many raised dividends through 2023. Investors who held a mix rode it out far better than those who had concentrated in rate sensitive yield.
When cash competes with dividends
When Treasury bills and money market funds pay 4% or 5%, they become real competition for dividend stocks yielding 3%. That doesn’t make dividend stocks a bad idea: cash pays no growth, and its yield falls when rates fall, while a good company’s dividend usually keeps rising. But it raises the bar. An income stock now needs to offer growth or a meaningful yield premium to be worth the extra risk.
| Ticker | Name | Yield | 1Y total return | 5Y total return |
|---|---|---|---|---|
| SGOV | iShares 0-3 Month Treasury Bond ETF | 3.60% | +3.7% | +20.4% |
| BIL | State Street SPDR Bloomberg 1-3 Month T-Bill ETF | 3.45% | +3.7% | +19.7% |
| VNQ | Vanguard Real Estate Index Fund ETF Shares | 3.61% | +1.2% | +5.6% |
| O | Realty Income Corporation | 6.07% | -6.1% | +8.6% |
| NEE | NextEra Energy | 3.27% | -2.0% | +9.8% |
| DUK | Duke Energy | 3.81% | -4.6% | +37.7% |
| VZ | Verizon | 6.18% | +12.2% | +15.5% |
| PFF | iShares Preferred & Income Securities ETF | 6.47% | -2.1% | +3.4% |
| ARCC | Ares Capital Corporation | 10.20% | +3.2% | +46.2% |
| MAIN | Main Street Capital Corporation | 6.55% | -5.7% | +95.7% |
And when rates fall
The process runs in reverse. Falling rates usually lift REITs, utilities and other bond-like stocks, as their yields look attractive again and their borrowing costs drop. BDCs and floating rate lenders see their income shrink, and some trim their dividends. Money market yields drop too, which pushes savers back towards dividend payers.
Check your understanding
4 questionsWhy do high yield 'bond proxy' stocks tend to fall when Treasury yields rise?
Most BDC loans are floating rate. When short-term rates rise, BDC income usually…
Which group is usually most hurt by a sharp rise in long-term interest rates?
What's the most useful way for a long-term dividend investor to handle rate swings?
Related lessons
This lesson is for education only and isn’t financial, investment or tax advice. Tickers are used as examples of how things work, not as recommendations. Figures marked as live come from Dividend Duel’s market data and change daily. See our disclosure.