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High-Yield Investing In a Low-Yield Environment

This article was written by in Investing. 13 comments.


This is a guest article by Investor Junkie, focusing on alternative investments. This is a broad topic, so this article functions as a brief overview. There are many ideas within that deserve deeper explanation, something I’ll consider for future articles here.

Market turmoil is all around us. Last week, the 10-year US Treasury bond went below an unheard-of yield of 2%. Recently, the Federal Reserve formally announced that it will be keeping the Fed funds rate between 0% and 0.25% at least until June 2013. Savers are being punished, and traditional fixed income investments are yielding nothing. Investing for yield in this environment is very difficult. Where is one to turn to get some yield when a 5 year CD yields less than 3%?

In addition, inflation is expected to be around 3% this year, so any investment that yields less than this you are losing money in real terms. What are your options in this low yield environment? You do have no choice but to go up the yield curve. I won’t lie; some alternatives are risker than fixed income traditional fixed-income investments, though most have a low probability of default and generate much higher returns than government-secured investments. One could argue investments yielding less than the expected inflation rate is a risker investment. I would personally rather hold my money under my mattress than investing in a 10-year treasury bond.

Tokyo Stock Exchange InvestingThat being said, what are the options? Some are traditional investments, and others are alternative investments that you may have not considered previously.

  • Peer-to-peer lending
  • High-yield corporate bonds
  • Ginnie Mae bonds
  • I-Bonds
  • Municipal bonds
  • High dividend stocks
  • REITs
  • Master limited partnerships

Here is a brief summary of each of these.

Peer-to-peer lending

I’ve been investing with the peer-to-peer lending (P2P) service Lending Club for over two years. To see my process, read my Lending Club review for the details. So far I’m very happy with my 11.49% net annualized return. Peer-to-peer investing isn’t perfect though, and it is still a very new investment class. It has potential to be a viable alternative to high-yield corporate bonds, with possibly less risk. If we do see another recession, it’s possible P2P loans will default more frequently, and increased defaults will decrease investment returns.

High-yield corporate bonds

High-yield corporate bonds, otherwise known as junk bonds, offer higher yields than traditional government bonds and can be 3% to 4% higher than government fixed-income investments. Of course, the higher yields come with higher risk and have a higher chance of default. Unless you are investing six figures, you are best to diversify in this category via mutual funds or ETFs focused on these investments rather than buying individual junk bonds.

Ginnie Mae bonds

Ginnie Mae bonds are federally-backed bonds that offer higher rates than traditional government treasuries. With Ginnie Mae bonds it is often best to invest via mutual funds only because most investors will not have the capital requirements to buy directly. I discuss about Ginnie Mae investing in more detail on my blog.

I-Bonds

I’m a big fan of U.S. I-Bonds, and for the next 11 months these investments offer at least a 2.51% annualized return. That rate could be even higher depending upon the CPI calculation in October. Like government TIPS, I-Bonds follow the inflation rate. There are no state taxes to pay on interest. Federal taxes are only paid when you cash out unless the bonds are used to pay for higher education, in which case they are tax-free. Unfortunately savings bonds have an annual purchase limit, and the U.S. Treasury Department just announced an end to paper-based savings bonds. Next year, the maximum you can invest is $5,000 per Social Security number.

Municipal bonds

For higher-income individuals, muni bonds offer a decent after-tax return with a historically low chance of default. Unless you are investing six or more figures you are best to diversify via a mutual fund. Muni bonds typically offer 2% to 3% higher returns than federal government investments. The primary advantage to muni bonds is the lack of capital gain taxes, though in this low fixed-income environment, individuals in lower tax brackets might want to consider them as an investment.

Dividend stocks

Many dividend stocks have a higher return than government treasuries. You also have the added benefit of the stock possibly increasing in price over time. There are dividend ETFs that can diversify your investment. I personally like the dividend aristocrats, which have increased their dividends every year for at least the past 25 years. These might be considered boring stocks, but they typically offer decent returns for the long haul.

REITs

Real Estate Investment Trusts (otherwise known as REITs) are publicly-traded real estate companies. You can invest directly in a specific REIT or via a mutual fund or ETF. With the decline in commercial real estate prices, it might be a good time to get back into specific real estate sectors, and these investments have an almost inverse correlation to stocks. Traditionally REITs have offered a stable 6% to 7% return. REITs are typically best held in tax-deferred accounts because the investor’s profits are generally considered ordinary income rather than capital gains.

Master limited partnerships

This is one of the rarely-discussed investments that generates a consistently high yield, and low to payout in taxes. Master limited partnerships (MLPs) are similar to real estate trusts, but are usually best to invest in taxable accounts. Most MLPs are companies related to the transporting of commodities, such as natural gas and oil pipelines. Typically, their pricing is not related to price of the commodity itself, but based upon the transportation of that commodity. If you do your taxes yourself it might not be a good option to invest your taxable money. MLPs can be complex when filing your personal tax return. I discuss more about MLPs in detail on my blog.

To diversify your risk, one could invest in many of these above investments, and still yield a decent return that’s stable. This article is meant as a summary of possible investment options than can generate some yield. Please do more research before investing any of the above options. With any investment you should always determine your risk, and if unsure contact a professional. In case you didn’t know, all investments have risks. Past performance does not guarantee future returns.

How are you investing in this low yield environment?

tenaciousme

Updated February 26, 2013 and originally published August 24, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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Investor Junkie likes to discuss what it's like being an entrepreneur and investing. He's about making money work for you by talking about passive and active investments. View all articles by .

{ 13 comments… read them below or add one }

avatar Ceecee ♦53 (Newbie)

What a depressing time to try and make some money on investments. It feels as if only those who can execute those tricky “options” are doing well. I’m going for stable dividend stocks and trying to focus on cash flow instead of principal.

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avatar Luke Landes ♦127,550 (Platinum)

Thanks for the article, Investor Junkie! I haven’t explored any of these types of investments. I’m sticking to a stock market index fund for the long-term and haven’t invested much other than that. Originally, I had no opportunities with Lending Club because I live in New Jersey, but now it looks like they have a way to get around that restriction by using the Foliofn trading platform. I’m going to look into that first.

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avatar Investor Junkie

No problem. I’m not a fan of FolioFN though. IMHO it’s not really usable. It’s a shame though as it could add more liquidity to the lending club market.

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avatar Josh

There are some phenomenal REIT’s trading at low prices right now.

I feel like owning the dividend aristocrats is good investing practice in any economy. Many of them are paying 4% yields.

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avatar Peter Renton

Great article IJ. I have some money in most of these investments although I have taken out all my corporate bond money and put it into peer to peer lending, but of course you’re not surprised about that. After p2p lending my favorite investment is the MLP’s. The dividends they pay are simply some of the best available and for the most part these are stable companies with predictable yields.

@Flexo, I am not a big fan of Foliofn either but I know many investors who are having a successful time using it to invest in Lending Club. In fact, there was a post this morning from a PF blogger discussing just that:
http://www.beatingbroke.com/lending-club-selecting-investments/

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avatar OptiRate

The alternatives to CDs mentioned in this article are really not alternatives. CDs have a completely different risk profile. That is, CDs are essentially risk-free given the FDIC (for Banks) or NCUA (for Credit Unions) insurance. Every other product mentioned has substantial market and interest rate risk – unlike that of CDs.

CDs can be compared very well to US Treasuries, and some Munis (Municipal Bonds) as these bonds (CDs are essentially bonds) are risk free by virtue of (Federal or State) government guarantee. CDs offer substantial premium to US Treasuries -

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avatar Investor Junkie ♦199 (Cent)

Hi OpitRate,

I understand that and rate risk is just one type of risk. Keep in mind the FED just announced (which it’s never done before), how long they will keep their rate (and who knows it might go past this). Could the FED change their mind before this? Absolutely but doubtful based upon economic conditions.

Inflation risk is another, and IMHO is still a bigger risk. So which is the lesser evil? Either way you can lose money in real terms. So stating CDs are “risk free” isn’t really a true statement, especially at these unheard of low rates.

Every investment has risk. What that risk is isn’t always apparent.

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avatar OptiRate

CDs are one of the few investments where the principal and interest are risk free. All of the other investments listed above carry varying levels principal risk. You are right in that there other risks that will effect ALL investments – including inflation, rising / falling interest rates and others. However, CD investments are protected from principal risk and interest rate risk given that a) amounts are insured to $250k / account, and b) CDs typically have fixed interest rate meaning that regardless what happens in the market, the interest rate will remain fixed for the duration of term.

BTW, interest rate and inflation risks are very closely correlated. If inflation begins to creep up, the FED will be forced to raise interest rates. However, we are mere mortals and thus predicting the future is very difficult. What we can say however, is that it is not appropriate to compare CDs with P2P Lending, MLPs, and other investments where principal is not 100% guaranteed given widely different risk characteristics and widely different return expectations.

In addition, we find that people who invest in CDs (or who allocate a certain percentage of their portfolio to no-risk investments to CDs) are typically interested in preservation of capital, rather than return on capital.

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avatar Investor Junkie ♦199 (Cent)

My only comment is I look at all investments in terms of real dollars returned. If you lose money via inflation risk or market risk, what’s the difference? The net effect is the same.

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avatar qixx ♦1,895 (Half-Dollar)

I’ve seen a few other Lending Club reviews and nobody seems to have lower than an 8% return. I might have to look into that option again. My only question you did not answer is how risky do these different options seem to you. IE, Does P2P Lending feel more or less risky than govt I-bonds; etc.

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avatar Investor Junkie

I think Lending Club is similar to high yield bonds in return and risk.

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avatar qixx ♦1,895 (Half-Dollar)

Thanks. I might look to Lending Club before government bonds then.

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avatar OptiRate

Just to clarify. Government Bonds also know as Treasuries are typically considered risk-free. That is, the chances of government default (eg. not paying back the principal and interest) is virtually zero.

High Yield Bonds are typically issued by Corporations with relatively poor credit — the lower the credit rating (scale of AAA to D, where AAA is the safest) – the higher the chance of default (eg. your principal and interest are lost). Lending Club loans – my guess – would rank somewhere in the C+ to C rating category (as people with better credit are unlikely to willing to pay the rates demanded by Lending Club and would instead use traditional lending sources such as banks).

Nothing wrong in investing in Lending Club loans, just make sure that you understand the risk and make sure that you comfortable with the possibility of default. In many respects, this depends on your priorities – if you need to grow your money, then Lending Club and other High Yield Debt maybe the right option; if you need to protect your capital – then Treasuries and other risk-free instruments (including CDs) may be a better course of action.

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