In this low interest rate environment, it’s reasonable to look for ways to increase the income from your portfolio. Here are some investment ideas for those seeking a higher yield:
High Yield Bonds
A high yield bond is a bond with a lower credit rating than investment-grade corporate bonds and government bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds. Some may pay out 2.5% or more vs. a comparable-term investment grade bond fund.
The idea here isn’t to add more bonds to your portfolio, but to replace some of your investment grade bonds with high yield bonds. While that may increase your income, it may also your risk. Just make sure you understand the trade-offs.
There are a few ways to mitigate your risk with high yield bonds:
Don’t buy individual bonds or a concentrated fund with only a few holdings
Buy a fund that is shorter term, therefore somewhat lessening your exposure
Buy a target maturity fund that holds bonds for a certain date
Buy a fund that has a higher credit rating vs. its peers
Funds to consider: SJNK, SHYG, BSJJ, VWEAX
Reasonable portion of portfolio: 2% – 8%
Real Estate Funds
A real estate fund mainly invests in commercial and corporate properties, although some may include apartments and agricultural land.
Mutual funds and exchange-traded funds holding U.S. real estate are currently yielding about 3% – 3.5% while funds holding international real estate are yielding about 0.5% less. These are a great place to start if you don’t own any real estate funds in your portfolio now.
If you already own real estate mutual funds, but are looking for more yield, than you might want to complement your current holdings with a closed-end real estate fund. While the above yields are decent in today’s environment, some closed-end real estate funds are yielding 6% or more. Closed-end funds are usually a little more concentrated, so there may be added risk, but they do provide higher current income. Closed-end funds may also trade at a discount or premium compared to the Net Asset Value (NAV) of the investments held by the fund.
A closed-end fund should not be your only real estate holding, rather it should be held in conjunction with at least one other traditional real estate mutual fund or ETF.
Funds to consider: VNQ, FSRVX, REET, IGR, RFI
Reasonable portion of portfolio: 3% – 10%
Dividend Focused Funds
Dividend focused funds simply hold stocks of higher dividend paying companies. Dividend focused funds are typically classified as U.S. Large Value although some “dividend growth” funds are classified as U.S. Large Blend. They typically pay a yield of between 0.5% – 1.0% higher than standard large blend and large value funds, but be aware that they are more concentrated.
Tilting your portfolio towards dividend paying stocks does not have to stop at the U.S. border. There are a growing number of international and emerging market dividend focused funds as well. Just keep in mind the asset classes of the funds you add and be aware of how you’re changing the portfolio. If you have 15% in U.S. Large Value and you want to add 5% to a similarly classified dividend focused fund, do you want to have 20% in U.S. Large Value, or do you want to stay at 15% and just have a tilt towards dividends?
Funds to consider: SPYD, HDV, VYM, VYMI, EDIV
Reasonable portion of portfolio: 3% – 12%
Utilities Funds
Utilities funds hold stock of utility companies and are typically classified as U.S. Large Value although some international funds do exist. Like dividend focused funds, they are concentrated but usually pay a yield of between 0.5% – 1.0% higher than standard large value funds.
Utilities funds could also add diversification to your portfolio as they are considered a defensive investment. Defensive stocks tend to perform better during recessions but may lag other stocks during growth periods.
Funds to consider: IDU, XLU, VPU, JXI
Reasonable portion of portfolio: 2% – 8%
Preferred Stock Funds
Compared to common stock, preferred stock has priority on the earnings (guaranteed dividends paid before common stock) and assets (in case of bankruptcy) of a company. However, preferred stock usually has less potential for appreciation. Preferred stock is sometimes referred to as a “hybrid” investment since it has both stock and bond characteristics.
Preferred stock funds can offer a yield of 5% or higher. They are not highly correlated to stocks or bonds, so they can also provide some diversification as well. Preferred stock funds, however, have several risks to keep in mind:
They may be highly concentrated with as much as 90% in financial companies
They usually hold companies with lower credit ratings
They are very sensitive to interest rate movements, like long-term bonds
Funds to consider: PFF, PSK, DFP
Reasonable portion of portfolio: 2% – 8%
Master Limited Partnership Funds
Master Limited Partnerships (MLPs) are limited partnerships that are publicly traded on an exchange. MLP funds hold various MLPs with a focus on energy infrastructure (natural gas and oil pipelines). An easy way to think of this investment is to envision owning a toll road. Energy companies pay a “toll” to use the MLP’s infrastructure to transport their product throughout the country. This “toll” is used to pay income to MLP fund owners.
MLP funds can offer yields comparable to high yield bonds and returns like stocks but they are considered “alternative” investments. They have a pretty low correlation to stocks and bonds so they could offer some diversification, but that doesn’t mean they aren’t volatile. MLP funds have had a wild ride over the last few years. For example, the annual returns for AMJ from 2011 – 2015 were 3.9%, 26.5%, 3.8%, and -33.0%. Towards the end of October, the investment was up about 14% for 2016.
Funds to consider: AMJ, MLPX, MLPI
Reasonable portion of portfolio: 2% – 7%
Income focused investments can increase the yield and income from your portfolio, but they are not a silver bullet. They should only be used as complimentary pieces within a well-diversified portfolio.
Terry Green, CFP® is the owner of Blue Water Capital Management, LLC, a fee-only financial advisory firm in Apex, NC.
