We turn on the water faucet every morning to brush our teeth and make our coffee. We click on the oven or the stovetop burner to cook our meals. We power up the heat when the air outside starts to chill or the AC on when the weather warms up. And then, like clockwork at the end of every month, we pay each of our utility bills. 

Most of the time, utilities don’t come with many surprises. And, while costs always seem to go up, it’s usually a little bit at a time. But you likely already know this. Utilities are just part of life. Still, it’s possible that you’ve never considered the following: what would it look like if you invested in your utility services and they paid you like clockwork, as well?

Utility investments offer a unique way to diversify a portfolio— providing stability and returns almost as predictable as your monthly bill. Here’s why you should consider a utility-related investment product before your next billing cycle.

What qualifies as ‘utilities’?

Utilities include electricity, natural gas, and water and waste services. 
American Water Works (NYSE:AWK), for example, is the largest publicly traded water and wastewater utility in the U.S. Through its subsidiaries, it services approximately 3.4 million active customers in 16 states. Over the last three years, it managed to grow its earnings per share by 9.1% per year, over three years. This past year, its revenue grew by 4.3% to US$3.6b. 

The utility sector increasingly includes wind and solar. For example, NextEra Energy (NEE), which invests in renewable energy infrastructure, has performed well overall since its market debut. 

At one-point telephone and cable companies were strictly regarded as utilities. In some cases, they still are (specifically landline services). But, improved technology and a changing, increasingly competitive market is transitioning them to part of the communications sector rather than a public utility. 

Utilities, including electricity, natural gas, and water and waste services, typically have monopolies in the geographic regions that they serve. In part this is because the cost of building and maintaining a power plant, a grid network required for distribution of electricity, etc., and the customer service infrastructure to collect payments and meet the needs of mass users is expensive. 

While the stability of no competition and a reliable customer base generally means that utilities are less impacted by economic downturns than other companies, it also means that they are regulated. 

Regulation means that a government entity at the local, regional, and/or federal level participates in oversight. Typically, oversight would include the monitoring of utility rates for customers, regional growth rates, and service reliability. It limits the ability to easily make rate increases to adjust for a profit margin, for example, requiring that price increases be both necessary and approved. 

Why invest in utilities?

Utilities are not a choice investment for making fast cash, rather they are a great way to diversify your portfolio. Considered a defensive investment, utilities can be a great tool to reduce overall risk. Utilities are generally regarded as a safe investment, more correlated with bonds than stocks, for a couple of reasons.

First, because utilities participate in a regulated industry, competition is generally stable and limited. They also rarely go out of business and because they have consistent customers who don’t have other options, they tend to have consistent revenue. 

Second, because they are regulated entities, they have very predictable cash flow and profits. This allows utilities to pay consistent dividends, generating steady income for investors. They also pay relatively high dividends (typically 60 to 80 percent of their annual earnings) to shareholders in part because they have little need to reinvest earnings into operations. The need for energy resources to power our refrigerators, water from our sinks, etc. is all consistent regardless of the strength of the economy. 

Investing in utilities that offer wind and solar opportunities can also provide a way for investors interested in environmental, social and governance to financially support companies aligned with sustainable values. 

How to invest in utilities 

Because of their infrastructure requirements, however, utilities tend to carry a lot of debt. This makes them vulnerable to rising interest rates. Higher interest rates both typically lower stock prices and increase debt for utility companies. 

There are a number of ways to invest in utilities, but it’s most often wise to look for a mutual fund, exchange-traded fund, or company with diversified holdings. Diversification limits some degree of risk in the case of a natural disaster that damages infrastructure, for example. 

However, utility-focused ETFs and mutual funds are a good way to access this sector without investing directly in individual utility providers. A search on Magnifi suggests there are a few different ways to do this.

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The information and data are as of the June 30, 2020 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.

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