Fixed-income alternatives for conservative investors
Many readers tell me that they are frustrated with the lowrates associated with safe investments.
That is understandable. Even with low rates of inflation, if you have substantial investments in money-market instruments or certificates of deposit, you are not staying ahead of inflation.
Money market funds pay almost nothing, as do most bank accounts. The 10year Treasury note yields about 0.70%. After taxes and inflation, youwould be receiving a negative return.
Fortunately, there are investments that do provide higher returns. They are not risk free, but I do believe that taking the risk is justified for some of the fixedincome alternatives. Inmy own portfolio, I havemaintained substantial investments in municipal bond funds, corporate bond funds and preferred stock exchange-traded funds (ETFs) that have provided consistent returns, well above those of the most conservative investment alternatives.
Here are some examples:
Municipal bonds
Because ofmy age, (well past 70 1⁄2) I am required to make substantial required minimum distributions (RMDs) each year (with the exception of 2019, thanks to the coronavirus relief bill) frommy retirement accounts. Naturally, Iwould like to minimizemy federal tax liabilities associated with the investments Imake with distributions not required formy recurring living expenses. I have found that investing in a long-term municipal bond fund is an attractive option. I prefer a fund (or ETF) that contains a diversified portfolio, because I don’twant to be dependent on the risk associated with one state or municipality. I have found that the total returns have been very consistent. All the interest paid is exempt fromfederal income tax.
My primary choice has been Vanguard’s Long-Term Tax-Exempt Fund (VWLUX). (Note, however, that you can find comparable returns from the funds/ ETFs of other major investment companies. Interest is paid monthly.) The expense ratio ofVWLUXis a low0.09%. The total year-to-date (Y-T-D) return for 2020 is 3.78%. The one-year returnwas 4.34%; for five years, 4.51%; for 10 years, 4.60%. The returns have been consistent.
There is no guarantee that these returns will always be positive on a shortterm basis, but if you are a long-term investor, inmy opinion, your investment risk is minimal. So if you are looking for consistent tax-free income for investments outside of your tax-deferred retirement plans, this is an alternative you can consider.
Corporate bonds
For many years, I have been investing in Vanguard’s Intermediate-Term Investment-Grade Fund (VFIDX) inmy retirement account. Again, I believe investing in a diversified fund or ETF to limit investment risk. Investing in an investment grade fund also limits investment risk and provides you with consistent income for long-term investment. Interest for this fund is paid monthly. The expense ratio is lowat 0.10%. The total Y-T-Dreturn is 8.37%. The one-year returnwas 9.07%; three years, 6.09%; five years, 5.21%. As you can see, the returns have been consistent. For conservative investors, I believe investing in diversified investment-grade bond funds is prudent and provides very good, consistent returns.
Preferred stocks
I have also invested in iShares Preferred and Income Securities (PFF), a large ETF, inmy retirement account. Again, I prefer the diversification associated with an EFT or fund. Preferred stocks are generally issued by corporations whose credit rating is belowinvestment grade. However, investors are rewarded with higher returns, and issuing corporations must pay preferred shareholders before they are allowed to pay dividends to holders of common stock.
PFF, which is the largest ETF investor of preferred stock, currently has a yield of 5.1%. These dividends are paid monthly. I have held the stock for seven years, and each dollar I invested seven years ago is nowworth approximately $2.70. Dividends have been paid each month and have increased consistently.
If you are a long-term investor interested in consistent high dividends for part of your fixed income portfolio, you can consider an investment in a large, diversified preferred-stock ETF that restricts its investment to low-risk preferred. (You can review past performance of ETFs atMorningstar.)