It is hard to believe that just a year ago, the U.S. economy was virtually in free fall, a victim of the pitiless coronavirus pandemic. Unemployment rates soared, yields on Treasuries plunged to record lows, and fear gripped financial markets. Today the environment is nearly the reverse: Economic growth is gaining steam, helped along by trillions of dollars of federal government stimulus; inflation is picking up; yields on Treasuries are rising; and investors are embracing risk again. // Although the economic story is brightening, the same cannot be said for investors seeking income and yield. The S&P 500 index of large-company stocks continues to establish record highs but yields only 1.4%, one of the lowest rates in market history. Interest rates on investment-grade bonds such as Treasuries and high-grade corporate debt are still remarkably low by historical standards and vulnerable to rising rates (bond prices and interest rates move in opposite directions). For example, iShares 20+ Year Treasury Bond, an exchange-traded fund that holds a basket of long-term Treasuries, has lost 12.5% for the year to date, which is six times its yield. Matt Pallai, head of Harbor Funds’ multi-asset solutions, says, “What we see now across the world is that income is one of the most scarce resources.”
With that challenge in mind, we set about searching for income opportunities in eight different asset classes, including bonds, stocks, real estate investment trusts, and master limited partnerships. We can’t do anything about the interest rates available today in categories including municipal and investment-grade bonds, which generally seem to offer low yield with considerable risk, but we believe we have turned up a number of interesting investment opportunities. This guide is intended to help you navigate today’s challenging income landscape.
Before you reach for some attractive yields, it pays to keep a few considerations in mind. You should have a financial plan in place, combined with a strong sense of appropriate long-term portfolio allocations. Everyone’s situation is unique, but generally you should ensure that you have enough cash or cash equivalents on hand to fund six months or a year of living expenses before you invest in high-risk/high-return assets such as stocks and high-yield bonds. Prices, yields and other data are through April 9.
0%–2% SHORT-TERM ACCOUNTS
Yields on short-term, fixed-income accounts take their cue from Federal Reserve policy. Therein lies a problem for holders of cash and short-term liquid assets: The Fed is keeping short-term rates near zero today and has telegraphed that it intends to adhere to this policy for at least a couple more years. Therefore, yields available on money market funds, certificates of deposit and short-term Treasuries are microscopic.
THE RISKS: Assuming an inflation rate of 2%, money you hold in cash reserves and liquid assets is losing purchasing power. Yet safe cash equivalents are required for emergency reserves and to meet near-term liabilities, such as taxes or tuition payments. This may be a time to keep cash equivalents to a minimum and, for liabilities more than a year away, to consider options with a bit more yield and slight risk.
HOW TO INVEST: For an example of the bleak environment for income on short-term accounts, consider VANGUARD FEDERAL MONEY MARKET (SYMBOL VMFXX, YIELD 0.01%). Even with Vanguard’s rock-bottom fees, you’re only able to earn one pitiful basis point. So-called high-yield savings accounts and CDs offer a bit more. FDIC-insured MARCUS BY GOLDMAN
SACHS offers a 0.5% annual rate for an online savings account with no minimum balance and 0.65% for a ninemonth CD with a $500 minimum balance.
Very short-term, high-quality bond funds have suddenly become popular for investors seeking to squeeze more basis points out of cash. These funds typically have a duration (a measure of interest-rate sensitivity) of less than 1, which means they fluctuate only marginally with interest-rate movements, and hold short-maturity Treasuries, asset-backed securities and investment-grade corporate bonds.
VANGUARD ULTRA-SHORT-TERM BOND (VUBFX, 0.43%) is a good example; exchange-traded funds of the same genre include
PIMCO ENHANCED SHORT MATURITY ACTIVE (MINT, $102, 0.33%) and INVESCO ULTRA SHORT DURATION (GSY, $50, 0.37%). Just remember that these funds have a slight amount of risk, so they’re better matched with liabilities a year or more into the future.
Normally we wouldn’t recommend a fund with a duration of 1.5 for liquid assets, but we’ll make an exception for FPA NEW INCOME (FPNIX, 1.65%). This is because of the fund’s superb record of risk management and capital preservation over the years. Steered by Tom Atteberry since 2004 (comanager Abhijeet Patwardhan joined in 2015), New Income has never lost money in any year since its inception in 1984. Fixed-income holdings include asset-backed securities such as auto, credit card and equipment receivables, residential securities, and short-term Treasuries.
1%–2% MUNICIPAL BONDS
Issued by state and local governments in the U.S., muni bonds pay interest that is free from federal taxes and, for bonds issued in your state of residency, free from state and local taxes as well. When large swaths of the economy virtually shut down in the pandemicridden spring of 2020, the normally stable muni market suddenly turned volatile. Muni prices slumped (and yields rose) at the same time that Treasuries, benefiting from a panicdriven flight to quality, gained in price. For a window of time, tax-free munis yielded even more than taxable Treasuries and many corporate bonds. But that window soon shut.
THE RISKS: The main risk now may be that muni valuations are extremely rich by several yardsticks, including wide yield discounts compared with Treasuries of the same maturity. Munis staged a powerful recovery over the past year, pressuring yields, as the federal government shoveled fiscal stimulus to state governments, tax collections came in ahead of expectations and investors returned to a somewhat supply-constrained market. Some financial advisers, such as Andy Kapyrin at RegentAtlantic, have even temporarily stopped investing in munis because the math for a higher after-tax return (relative to taxable bonds), especially for short-term munis, doesn’t work even for taxpayers in the highest tax brackets.
HOW TO INVEST: Munis still have a few things going for them. Defaults are rare—much lower than for investment-grade corporate bonds with the same credit ratings. Munis have very low correlations with stocks and other “risky” assets, which means that they add a diversification benefit to an investment portfolio. They should also benefit from looming tax changes. “Taxes are definitely going up with the new administration, which bodes well for munis,” says David Albrycht, chief investment officer of Newfleet Asset Management.
You can gain exposure to a welldiversified basket of muni bonds by investing in a national muni fund.
FIDELITY INTERMEDIATE MUNICIPAL INCOME (FLTMX, 0.75%) is a member of the Kiplinger 25, the list of our favorite no-load funds. Adjusted for the maximum federal tax rate of 37% plus the 3.8% Medicare surtax on net investment income, the fund’s tax-equivalent yield is 1.27% (or 0.99% for investors in the 24% tax bracket). More than 80% of holdings are rated A or higher. The largest sector is health care; the two biggest state exposures are Texas and Illinois.
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