Better High-Yield Dividend Stock: AGNC Investment vs. Ares Capital Corporation

If you're looking to earn passive income from your investments, look no further than dividend stocks. However, not all dividend stocks are alike. Some companies pay dividends that grow over time. Others take a more aggressive approach with high dividend yields that are more vulnerable to future cuts.

If high-yield dividend stocks sound appealing to you, two companies that have likely made it onto your radar are Ares Capital Corporation (NASDAQ: ARCC) and AGNC Investment (NASDAQ: AGNC). These two companies boast impressive yields of more than 10%, but have very different business models. Here's what you need to know if you're considering investing in either of these high-yield dividend stocks.

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Comparing Ares Capital and AGNC Investment

Ares Capital Corporation is a business development company (BDC) that invests in middle-market companies, primarily through debt and equity investments. In recent decades, banks have preferred lending to larger institutions, leaving middle-market companies behind. Ares Capital has found its niche in lending to smaller companies, and has a dividend that yields 10%, a reflection of the riskiness of these loans.

AGNC Investment, on the other hand, is a mortgage real estate investment trust (mREIT). Unlike traditional REITs, AGNC invests in government-backed mortgage-backed securities. Since recent mortgage rates average around 6%, the company uses leverage -- essentially borrowing -- to boost its returns enough so that it can offer an attractive dividend yield of 13%.

Private credit risk has affected BDCs like Ares Capital Corporation

Each company has its own unique risks. For Ares Capital Corporation, there has been a ton of news around private credit and BDCs. Notably, investors have grown concerned about loans extended to software companies. These companies have taken a hit this year amid concerns that artificial intelligence, notably agentic AI, could upend many software companies' business models that have done so well in recent decades.

Amid this volatility, Ares Capital stock has fallen almost 20% from its 52-week high. The company has sizable investments in software, which make up 24% of its total loan portfolio. Management has noted that the loan-to-value on its software book is 37%, providing it with a large cushion that could withstand major writedowns before it would affect Ares Capital.

In addition, Ares utilizes a dedicated software credit investing team, alongside an in-house venture capital AI team (Bootstrap Labs) that it acquired a few years ago, to assess technology risks for every new deal and during quarterly portfolio valuations. Another important difference between Ares Capital and some of those private credit BDCs is that Ares Capital is publicly traded, letting investors get in or out of their position at any time.

AGNC Investment is vulnerable to changes in short- and long-term interest rates

AGNC Investment faces a different risk from interest rate fluctuations. Most notably, changes in short- and long-term interest rates, and the difference between the two, are where AGNC's underlying business model is sensitive. That's because the company uses leverage by borrowing on a short-term basis and investing in longer-term mortgages.

In 2022, when the Federal Reserve began hiking interest rates, the company saw its margins compress and book value fall. That's because interest rates on both the short end and long end of the yield curve rose, with short-term rates rising more quickly. More recently, the company has benefited as short-term rates have fallen since the Fed began cutting rates in 2024, while the longer end of the curve has remained more elevated.

Looking ahead, AGNC will remain vulnerable to interest rate volatility. But if the Fed continues to cut rates, it will lower short-term borrowing costs, which could steepen the yield curve and boost AGNC's earnings.

The high-yield dividend stock I would buy right now

High-yield dividend stocks pose unique risks to investors. AGNC is vulnerable to interest rate fluctuations, but could deliver solid returns if the short end of the yield curve falls while longer-term mortgage rates remain elevated.

Ares Capital, on the other hand, is vulnerable to deteriorating macroeconomic conditions and other factors that affect its borrowers' ability to repay their loans. If you believe private credit issues will persist, and are concerned about software and the effect on AI, you may want to avoid the stock.

Still, Ares Capital has a long history of navigating different economic environments during the past two decades, including the Great Recession in 2008 and the pandemic-induced recession in 2020. The company has done a good job of increasing its dividend, while AGNC has had to cut its payout several times during the past decade.

With Ares Capital trading at a 7% discount to net asset value, I think it's a more reliable high-yield dividend stock for investors to scoop up today.

Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Ares Capital. The Motley Fool has a disclosure policy.