How dividend investors are adjusting their portfolios in response to the Fed

July 31, 2025 at 10:48 AM EDT

The Federal Reserve remained on hold with interest rates this week, despite pressure from President Trump and two of his Fed appointees to lower rates now. While the Fed’s next move is likely to be a rate cut, it is not clear how soon that will come after remarks from Fed Chairman Jerome Powell that many considered hawkish.

While the default position was for a very quick pivot to rate cuts, persistent inflation and better-than-expected economic data have led to a baseline expectation of higher-for-longer interest rates. This transition is fundamentally shifting the landscape for income investors.

During the last era of near-zero interest rates, dividend stocks were instrumental in income-oriented portfolios as a means of allowing yield and upside potential via equities. But with Treasury yields, CDs and money market funds now offering risk-free returns above 5% in some cases, the appeal of dividend stocks is being re-evaluated.

The changing appeal of dividend stocks

Income investors are having to undergo a fundamental shift in thinking around income investing with the Federal Reserve largely committed to a regime of high interest rates. U.S. 10-year Treasury yields recently popped up to a high near 4.5% just as the S&P 500 dividend yield is around 1.24%.

While the 10-year has since retreated closer to 4.35%, risk-free or low-risk instruments, such as Treasurys, CDs and money-market funds, are still yielding well above many dividend paying equities. Operating within this paradigm, investors face a distinct choice:

Safety & certainty: Fixed income products provide both yield and return of principal guarantees which carry great appeal in uncertain markets.
Equity upside & growth: With dividend stocks, you can have factors of modest yield and potential share appreciation along with alternative dividend growth assuming the risk-intended price volatility.

For investors comparing ~4.5% yield from a Treasury note to 1-1.3% yield from S&P 500 dividends the choice is clear for those seeking income preservation as a choice over growth.

However, dividend stocks are still attractive in a longer time horizon for longer term investors seeking total return — a modest yield and some combination of share appreciation and dividend increases. As a point of reference, S&P 500 dividend growth reached about 7.5% year-over-year through mid-2025, which would serve to make equities appear more attractive over time.

Ultimately, in this “higher-for-longer” rate environment, many investors find themselves in the position of rebalancing portfolios — moving short-term income allocations from equities to fixed income while still being selective with dividend-paying equities in a total return strategy.

Dividend growth vs. high yield

With interest rates being high right now, the dichotomy of high-yield vs. dividend-growth style stocks has never been more clear for investors. With a growth focus, investors are taking a fresh look at exposure to income (income meaning not only yield, but erosion of capital, stability and ultimately long run total return).

High-yield stocks may appear to fit the income profile, but they are typically found in sectors such as real estate, energy and telecom where the volatility, cyclicality or leverage of the entity is an unknown variable. Payout ratios—when most of a company’s earnings are paid as a dividend—usually fall below 80%, ,but the risk of yield becomes elevated when payouts breach the 80% threshold, which suggest dividend sustainability is much more susceptible during economic headwinds.

Whereas, dividend-growth stocks are typically found in consumer staples, healthcare and industrials, they tend to have lower yields, but often convey a more consistent income growth profile over a considerable timeframe. These companies usually have low payout ratios, with strong free cash flow, and earnings resilience to grow annually in dividends. Historical data suggests that companies with a track record for growing dividends often outperform over full market cycles, due to greater capital discipline and strong balance sheets.

A significant number of investors who focus on income are now shifting toward total return strategies—focusing on sustainable dividend growth and capital appreciation as well as yield. Rather than just a high yield, this means prioritizing a company with sustainable investments that have durable earnings and a competitive advantage that can grow payout over time—even in a stagnant economy.

Instead of focusing on the best yield, selective sourcing is rewarded in today’s environment. Developing a strategy that focuses on dividend durability and dividend growth potential, based in strong fundamentals, allows investors to develop an enduring income position in an uncertain economic and monetary environment.

Portfolio adjustments

Income investors are using strategies to adjust their portfolios to address a high-rate environment. An example of three common strategies are diversifying income mixes (not rely solely on dividend equities, but into dividend and some bonds); shortening fixed income duration; and splitting the equity/bond exposure.

Income investors are diversifying income mix from dividend equities into a blend of dividend-bear and bond income. Bond ETFs have seen very strong inflows—over $5.3 billion the recent week—which include growing interest and stronger flows into intermediate-duration Treasuries to bring in stability. There are also many new innovations including iShares iBonds ETFs allowing investors to more easily create structured bond ladders which provide predictable returns as well as control over maturity dates.

With these strategies, we see the growth of short-duration bond funds, and hybrid strategies including target-weight or laddered strategies to combat rate risk. Short-duration bonds and bond ladders give the income investor more flexibility with current yields locked in, while other more innovative hybrid duration products (often equity-income or target-maturity ETFs) are also rising in popularity which provide diversified exposure across bond ETFs and dividend paying equities.

Dividend ETFs are getting some use. Utilities, (i.e., XLU) as an example, have not performed well—flat to down ytd—but they are still attractive as defensive anchors, especially if the Fed waits to signal a rate cut.

Outlook: What to expect for the rest of 2025

Fed moves: Most analysts still expect at least one Fed rate cut yet this year, but any pivot to “easiness” will depend on inflation and if the economy is resilient.
Inflation stickiness: While the numbers are getting close the the Fed’s inflation target of 2%, uncertainty remains concerning the effects of tariffs on prices. Higher inflation could keep yields elevated, and that will impact bond returns.
Soft landing: Any slowdown without a recession would generally benefit shorter duration fixed income and dividend equities with solid fundamentals.

In this environment income investors are building portfolios where there is a balance of shorter duration bonds, laddered funds, and dividend equities — while being aware of macroeconomic triggers. Flexibility and diversification, rather than steady allocations, are becoming important as we move through the remainder of 2025.

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How dividend investors are adjusting their portfolios in response to the Fed

The changing appeal of dividend stocks

Dividend growth vs. high yield

Portfolio adjustments

Outlook: What to expect for the rest of 2025

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