Alternatives for higher investment income

By Elliot Raphaelson
Posted on July 05, 2016

I have often written that even conservative investors can’t afford to restrict their investments to low-paying alternatives such as certificates of deposit, money-market accounts and Treasury bills.

Even in retirement, I believe a diversified portfolio that includes a significant investment in some form of common stocks and bonds is best. (Although I have been retired for about 20 years, I still maintain about half of my portfolio in equities.)

Bond investors do not have to restrict themselves to conservative investments. There are several attractive options that, on an intermediate-term and long-term basis, will likely outperform Treasury bills and other conservative investments.

Intermediate-term bonds

One option I have used for many years is mutual funds (or ETFs) that invest in intermediate-term investment-grade bonds.

I have invested in Vanguard Intermediate-Term Investment-Grade Fund Admiral Shares (VFIDX) for several years. This year (as of May 16) the fund has earned 4.34 percent; three-year returns are 3.15 percent; five-year returns are 4.7 percent; 10-year returns are 6.05 percent. The expense ratio is 0.10 percent. The current SEC 30-day annualized yield is 3.04 percent.

Another option I have used for many years is the Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX), which is a little more conservative and also invests predominantly in intermediate-term bonds. This year the fund has earned 3.78 percent; three-year returns are 2.51 percent; five-year returns are 3.41 percent; and 10-year returns are 4.96 percent. The expense ratio is 0.07 percent. The 30-day SEC annualized yield is 2.45 percent.

I invest in Vanguard because their funds are generally managed conservatively and their expense ratios are generally low. (I prefer mutual funds over ETFs because I regularly withdraw funds monthly and reinvest earnings monthly.) Fund families other than Vanguard will have similar funds as well as ETFs.

These alternatives are reasonable if you are willing to take some risk and are not investing short-term. If you expect to need to sell these investments soon, you should be investing in money-market funds, T bills or short-term CDs.

High-yield funds

For the last 20 years, I have also maintained a significant portion of my bond portfolio in Vanguard High-Yield Corporate Fund Admiral Shares (VWEAX).

Vanguard is more conservative than most of the other high-yield bond funds. Because of the company’s relatively conservative approach, the yield on this fund is a little lower than that of some competitors. However, when the value of high-yield funds decreases because of anticipated increases in interest rates and pessimism about corporate earnings, Vanguard’s high yield fund will generally outperform its competitors in down markets.

Year-to-date returns for this fund are 4.5 percent; three-year returns are 2.84 percent; five-year returns are 5.53 percent; 10-year returns are 6.41 percent. SEC yield 5.54 percent. The expense ratio is 0.13.

I do not recommend that you invest in high-yield funds unless you are a long-term investor and you will not sell when the value of the shares fall because of anticipated increases in interest rates or stock market doldrums.

There is a high correlation between dramatic decreases in stock prices and the value of high-yield funds. However, the percentage decrease in the value of high-yield funds is generally lower than the percentage decrease in common stock values during market downturns.

I maintain a high percentage in high-yield bond funds because it allows me to invest less in the stock market. When the stock market does well, high-yield funds do well also, but there is much less volatility with the high-yield bond fund in comparison to the stock market in general. In addition, the yield from high-yield funds is generally much higher than the yield from mutual funds specializing in high-dividend stocks.

Elliot Raphaelson welcomes your questions and comments at elliotraph@gmail.com.