Think Outside the Bank to Boost Yield
We offer a wide-ranging menu of investments offering increasing yields.
As we move into 2014, it's not getting any easier to collect a satisfying—or even noticeable—yield on your savings. Interest rates on savings accounts, certificates of deposit and money-market accounts will move up slowly this year, at best. It won't matter much whether the Federal Reserve trims its bond-buying program this month or next month, or waits until late in the year. So much cash is sitting idle in banks and other financial institutions that lenders can't jack up rates on loans. And that means they won't need to offer savers a meaningful raise to attract more cash. The best one-year certificate of deposit today pays 1.05%. In a few months, that might rise to 1.15% or 1.25% at best.
Fortunately, skimpy bank rates aren't your only option. Later, we'll offer a wide-ranging menu of investments offering increasing yields. But first we'll set the table with an opportunity to ride rising mortgage interest rates to higher yields.
A 30-year fixed-rate home loan closes now at an average of 4.3%, up from 3.5% a year ago. The easiest way for investors to ride along is with shares of a Ginnie Mae mutual fund. The funds own pools of government-backed home loans and pass interest and principal payments on to investors. Currently, you can capture a yield of close to 3%. That's up a percentage point from a year ago.
Unlike savings accounts, of course, the mortgage bonds' value varies with interest-rate action. During 2013, for example, the share price of Vanguard GNMA (symbol VFIIX) bounced as low as $10.26 and as high as $10.93—reflecting the ups and downs of the underlying securities. The fund's monthly income also changes. If mortgage rates continue to inch higher, this and other similar funds will buy new loans that pay higher interest. That's why Vanguard GNMA's monthly distribution is up sharply since mid 2013. This offsets the declining market value of the fund's older, lower-rate mortgages. So its most recent yield, based on the latest dividend payment, is 2.6% and rising. Total return is 0.6% the past three months.
If you need more income, you should pursue both interest, which is fixed, and stock dividends, which often go up each year. You can tap into an array of cash flows from business sales and profits, as well as the interest on bonds, loans and mortgages.
Many experts cast several nets with their own family savings. Mary Ellen Stanek, director of asset management for the parent company of Baird Funds, advises her mother, who is in her eighties, to "just walk along" in high-quality short-term and intermediate-term bond funds. This earns her mother about 2%.
By contrast, Stanek's husband, a dentist in his fifties who is a few years from retirement, keeps an even balance between stocks and two higher-yielding and slightly risky bond funds, Baird Core Plus (BCOSX), which pays 2.6%, and Baird Aggregate Bond (BAGSX), at 2.8%. Both funds hold government, corporate and mortgage bonds, with the average maturities 7.1 and 7.0 years, respectively.
Stanek, who has supervised income investments for 34 years, currently likes quality municipal and corporate bonds, and she's confident that the domestic high-yield (junk) market will have another good year provided you don't dig to the bottom of the credit heap. She argues that so many Americans are seeking high yield from corporate bonds, mortgage funds and real estate investments, that the supply is tight, keeping yields down but principal values secure.
This may sound odd given all the handwringing over the dangers of the nation's debt. But Stanek's point makes sense, at least for 2014. Municipal bond issuance was 30% lower last year than in 2012. The Treasury is borrowing less now that the government's deficit is half what it was in 2011. And whenever a top-shelf company issues new bonds, as Verizon did recently, buyers swamp the offering.
So thinking outside the bank is not as fraught with danger as it appeared not long ago. Sure, bonds, bond funds, real estate investment trusts and some high-yielding stocks lost value last spring and summer over fear that interest rates were about to take off. But since July, nearly every decent bond fund and bond alternative, such as Ginnie Maes and property-owning REITs, has risen in value. They begin 2014 in good shape.
Kiplinger's expects interest rates will climb only a little this year and that the economy will grow 2.6% with continued low inflation. Based on that forecast, consider this menu of income investments we expect to be reliable in 2014. Yields are based on the latest monthly or quarterly payouts; total returns cited are for 2013, through December 5.
Yields Up to 2%
With a long-enough CD, you can hit this target. But why lock up your cash for several years when you can reach the same level with a low-cost short-term bond fund? You'll want a low duration—less than two years—so that if interest rates spike, you won't lose much, if any, money. (Based on the maturity of bonds in a portfolio, the duration estimates how a change in market rates would affect principal value.) Consider Baird Short-Term Bond (BSBSX), which yields 1.5% with a duration of 1.9 years. Metropolitan West Low Duration Bond (MWLDX) is equally fine. It yields 1.6% with a duration of just 1.2 years. (If rates go up a full percentage point, your principal should lose 1.2%. That would leave you with a net gain.) Both use government, mortgage and corporate debt.
Short-term municipal bonds and muni funds also have appeal, and not just for the tax exemption. Muni yields often exceed Treasury rates of the same maturity. You can buy noncallable A-rated munis directly for a yield to maturity of 1.5% to 2% for three to five years. Or use a fund such as T. Rowe Price Tax-Free Short-Intermediate (PRFSX) and get a current yield of 1.6%. That's equivalent to 2.3% on a taxable investment if you're in the 28% federal bracket, more if you factor in state and local levies. The duration is less than three years, and 99% of the holdings are investment-grade.
Yields From 2% to 3%
To get here you'll want to add dividends to the mix. Two terrific buy-and-hold choices that often add growth are the twin Vanguard balanced funds, Vanguard Wellington (VWELX) and Vanguard Wellesley (VWINX). Wellington is two parts stocks to one part bonds; Wellesley the reverse. With blue chip stocks' dividend yields and intermediate-term bond yields so close, this pair also converges: Wellington pays 2.4% and Wellesley 2.9%. (Total returns 16.7% and 7.5% respectively.) You get famous stocks such as Johnson & Johnson, Chevron and Microsoft, as well as a barbell-style bond position, which means short-term and long-term high-quality bonds, governments and corporates. These funds are ideal as core sources of income-with-growth. Then you can work in bolder stuff.
An alternative is to combine a general or flexible bond fund (or several) with dividend payers. A class of creative bond funds called unconstrained—or go-anywhere—fits here. Dodge & Cox Income (DODIX), which yields 2.9%, has low costs, a moderate duration of around 4 and a superb record. (Total return through December 5 was 0.2%.) Metropolitan West Unconstrained (MWCRX) yields 2.6% and combines junk bonds with short- and intermediate-term investment-grade debt. (Total return: 2.6%.)
Dividend stocks have become an income staple as companies build cash and raise dividends enough to keep the yields ahead of taxes and inflation. A Standard & Poor's 500-stock index fund such as Vanguard 500 Index (VFINX, or VFIAX if you invest $10,000 or more) yields just 1.8% now because stock prices are so high. (Soaring stock prices is why VFINX's total return through December 5 was an eye-popping 27.5%.) To get higher income, try a fund that owns only stocks with dividends. WisdomTree MidCap Dividend ETF (DON) yields 2.6% by trolling the expanding ranks of smaller companies that now pay dividends. Returning to blue chips, SPDR S&P Dividend ETF (SDY) holds stocks that have raised dividends yearly for 20 years. The quarterly distributions don't change much, but you usually get a year-over-year bump plus some growth. The fund yields 2.3%. (Total returns of these funds were 28.5% and 26.1%, respectively.)
Yields From 3% to 5%
This is the bridge from the simple and familiar to the bold and complex. Floating-rate bank-loan funds, whose few no-load entries include Fidelity Floating-Rate High Income (FFRHX), which yields 3.1% (total return 3.6%), and DoubleLine Floating Rate (DLFRX), which yields 2.7% (total return since the fund's February 1, 2013, inception is 2.9%), have become wildly popular from the combination of high yield, low duration, and the idea that if interest rates go up, the loans' rates will reset higher. Loan funds buy pieces of large loans that a group of banks extend to small and midsize businesses. The risk is that the funds will run short of sound loans, though managers say they can accommodate the fresh billions. Divide your money among at least two, even if you pay a small sales charge or higher fees because returns vary widely. Nuveen Symphony Floating Rate (NFRAX), for example, has a 3% load. But since its launch in 2011, it has more than made that up compared with the average bank-loan fund. Current yield is 3.7%; the 2013 total return is 7.4% through December 5.
Some flexible bond funds yield over 3% because they buy dicey stuff such as emerging-markets bonds or they stretch out the maturity. The gold standard, Loomis Sayles Bond (LSBRX), is more cautious than it used to be, but the fund still yields 4.3% (total return 4.4%) on a portfolio full of U.S., Canadian and Mexican bonds, mostly corporates and mortgages. Osterweis Strategic Income (OSTIX) invests in short-term junk bonds and yields 3.6% (total return 5.9%) without big swings in share price.
Some quality stocks normally pay about 4% in tax-advantaged dividends, although the long bull market means robust payers such as Kimberly-Clark (KMB) are now priced to pay barely 3%. Electric utilities best fill your wallet. Their earnings and share prices don't grow fast, so utilities will raise dividends only 3% or so for the next few years instead of the 8% common with industrial and consumer-products firms. Choose utilities that stick to rate-regulated power or gas and electric service. American Electric Power (AEP) is a favorite, with a yield of 4.3%. Other leaders are Duke Energy (DUK), Consolidated Edison (ED) and Southern Company (SO), which also pay 4% to 5%.
Yields From 5% to 8%
This is the top end of the yield range for everyday categories such as municipals and blue chips. Shares of AT&T (T) and Verizon (VZ) sometimes trade down a few dollars to yield over 5%, which is when buyers step in. A few real estate investment trusts also beat 5%, though a multi-year rally in REIT prices has most trusts in the 3% to low 4% range. You can get a hair over 5% in two sound REITs that own freestanding retail buildings, Realty Income (O) and National Retail Properties (NNN). Both were flat in 2013, making this a good time to enter. Another fine REIT with a high yield is Government Properties Office Trust (GOV), which pays 7% from renting space to the IRS, FBI and such. The market thinks there's risk here because the feds are strapped for money and presumably set to play hardball on new and renewal leases.
High-yield, or junk, corporate bonds normally pay five to six percentage points over Treasuries, so you've had chances aplenty to lock in 8% or 10%. Today's yield premium to Treasuries is just four points, a narrow gap that in the past sparked sharp selloffs. But as long as the alternatives pay so little, there's no reason junk in the 5% to 6% neighborhood will lose supporters soon. First-class no-load sponsors such as Fidelity (FAGIX), Metropolitan West (MWHYX), TIAA-CREF (TIYRX) or USAA (USHYX) do fine. So do many others that normally have sales charges—Hotchkis & Wiley High Yield (HWHAX) stands out—but are available without a sales charge to customers of certain brokerages such as Fidelity and Charles Schwab. At 4.6%, the current yield on the Fidelity fund is a tad below 5%, but its 2013 total return through December 5 is 8.2%.
The price of crude oil is falling and natural gas is cheap, but you can easily turn energy into high income. The most consistently high-paying income investment of them all is the master limited partnership, a tax-advantaged structure used by businesses that own pipelines, refineries, storage tanks, hydraulic fracturing (fracking) sand mines and other energy-related infrastructure. The big established groups such as Magellan Midstream Partners (MMP), Plains All-America Pipeline (PAA) and El Paso Pipeline Partners (EPB), to name three, are suitable to buy and forget. If current yield on any of these dips below 5%, it won't stay there long because a dividend boost is probably around the corner.
Super Yields of More Than 8%
The most realistic way to capture 8% is in a leveraged closed-end fund that owns high-quality municipal and corporate bonds or high-dividend stocks. The fund generates the extra income by borrowing to buy additional investments. Pimco is the source for a few worthy funds, such as Pimco Income Opportunity (PKO). It invests in an assortment of just about anything, foreign or domestic, that throws off high income. Pimco Corporate and Income Strategy (PCN) is similar. Both funds yield slightly more than 8% (total returns 9.3% and 8.0%, respectively) and are fine for mad money, or at the fringe of a widely diversified portfolio.
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