Searching For Yield

May, 2012
by Gerald Townsend, Financial Editor

If you are buying a new home or refinancing a mortgage on an existing home, it is a great time. However, if you’re older with your savings heavily invested in CDs and other short-term investments, you probably feel like you’ve been gut-shot.

The Federal Reserve, with a wary eye on our still wobbly economy has signaled their intention of keeping short-term rates near zero for quite a while, hoping this will spur investment, spending, and growth.

In this environment, where should an income-oriented investor be searching for yield?

Bonds

Fixed-income investments, such as bonds or bond mutual funds are usually the first consideration for income investors. However, with the 10-year treasury yield hovering around 2%, sticking to the safest bonds won’t generate much income.

When you are attempting to increase your yields on bonds you can either buy longer-term bonds or lower-quality bonds. In this environment, with a weak, but improving economy – I prefer dropping down on the quality more than lengthening the maturity.

Investment-grade corporate bonds and high-yield corporate bonds continue to offer attractive yields, when compared with treasuries.

Municipal bonds should certainly be considered, as some of them are offering yields higher than taxable-bond alternatives, even before you factor in their tax-exempt status. “Private activity” municipal bonds offer even higher yields because they are subject to the “alternative minimum tax.” However, if you are not in the grasps of the dreaded alternative minimum tax, you can benefit from the higher rates of these private activity bonds.

For those willing to incur a bit more risk there are “leveraged closed-end” municipal bond funds. Their risk (and their yield) is higher, because they are borrowing at short-term rates in order to invest in longer-term bonds.

Venturing away from U.S. shores, you can avoid the European sovereign debt and look at emerging-market government bonds. Yields vary, but compared with U.S. treasuries, you can obtain an extra 3% for emerging-market debt denominated in dollars for perhaps 4.5% extra for emerging-market debt held in local-currency.

Stocks

Investors have rediscovered dividend-paying stocks in recent years, and they continue to be an attractive alternative for yield-hungry investors. The yield on the Dow Jones Industrial Average is about 2.5% and the S&P 500 sports a yield around 2.2%. However, yields of 3% - 5% are achievable from a number of stocks in the consumer, healthcare, financial and utility sectors.

Master Limited Partnerships

Master Limited Partnerships or “MLPs” are limited-partnerships, but are publicly-traded, just like stocks. Because of their structure, they don’t pay any corporate tax and can pass much of their profits through to investors. Typically these are energy-related MLPs who collect fees for transporting oil and gas, no matter what happens to the actual price.

Real Estate Investment Trusts

Real Estate Investment Trusts or “REITs” have had strong returns in recent years, but continue to offer attractive yields to investors. Depending on the REIT, it may be invested in apartments, office buildings, shopping centers, healthcare facilities or timber.

When shopping for yield, it is important not to overreach. Any investment that is offering an unusually high yield – particularly if it is also being promoted as being safe or guaranteed – is best avoided. However, there are ways to increase your risk-adjusted yield in a safe, sensible manner.