High-Yield Investing In a Low-Yield Environment
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.
That 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
- Municipal bonds
- High dividend stocks
- Master limited partnerships
Here is a brief summary of each of these.
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’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.
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.
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.
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?