Despite the gloom, you must have utility stocks in your portfolio

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Who would buy stocks that only grow 8-10% per year when you have technology options that are doubling every year? Millennial investors might ask this question. However, a return should not be the only criterion when investing for the long term. You want to have an all-weather portfolio that should also provide passive income and stability.

Why the utility stocks?

Many investors overlook utility stocks because they do not have superior growth. However, when it comes to hedging high market volatility and reliable dividends, even the biggest fund managers look to utilities. During the 2008 financial crisis, utility stocks significantly outperformed growth stocks and even the S&P 500.

Utilities operate in a highly regulated environment and generate a specific rate of return. For example, Canada’s main public service Fortis (TSX: FTS) (NYSE: FTS) generates substantially all of its profits from regulated operations. They ensure stable earnings and dividends, which significantly reduces the risk for investors.

That is why Fortis has managed to increase its dividends over the past 47 consecutive years. Rarely would you see such a long streak of dividend growth in high growth tech stocks. Fortis is currently selling 4%. The stock has returned over 180% over the past decade, including dividends, outperforming Canadian stocks in general.

Interest rates and utility stocks

Interest rates across the world have hit record highs this year amid the pandemic. Investors should note that utility stocks and interest rates typically trade the other way around. Income-seeking investors are turning to utility stocks amid lower interest rates looking for higher returns. It also gives a boost to public services.

Utilities are heavily indebted on their books, and falling interest rates lower their debt service costs, ultimately improving their profitability.

If you are looking for reasonably higher growth and security, consider Algonquin Power & Utilities (TSX: AQN) (NYSE: AQN). The stock has returned nearly 700% over the past decade, absolutely crushing Canadian utility stocks and broader markets.

Algonquin’s high-growth renewable energy business provided a necessary boost to its earnings growth during this period. It trades at a dividend yield of 4%, slightly higher than that of TSX stocks as a whole.

Utilities don’t have a fancy business model or remarkable growth that doubles your money every few years. However, they stand tall when the markets as a whole take a turn for the worse. Regardless of economic conditions, people use electricity and gas, which facilitates stable cash flow for utility companies.

Algonquin aims to increase dividends by 7% per year, while Fortis aims for a 6% increase for the next few years. While this may seem ordinary against some dividend aristocrats, their stable and visible increase in payouts certainly stands up in these volatile times.

The insane takeaway

Utilities stocks are generally less correlated with larger markets. This is why they outperform bear markets.

So, whatever your appetite for risk, you should invest around 10-20% of your portfolio in utility stocks. The passive income generated by such a modest allowance will cover your expenses during your sunset years.

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Fool contributor Vineet Kulkarni has no position in any of the stocks mentioned. The Motley Fool recommends FORTIS INC.

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