Fixed Income Investing – What To Do
Here are some alternatives for fixed income investing and the types of people that invest in them. Keep in mind, the range of interest rates, desire for cash flow and safety of principal. All rates used here are estimates for illustration purposes. This should be read in conjunction with my previous blogs on bonds. If you want a single PDF file with all those blogs, send me an email request. Also, any opinions are strictly mine and are for suggestive purposes and assume the principal will not be needed sooner than the indicated investment terms. You are strongly directed to consult with your advisor before proceeding with any actions.
Keep in mind the primary criteria for fixed income investing is to get predicable interest and return of principal. Fixed income investors should not expect growth in their principal, although many of these choices will have widely fluctuating values from the point of issue until maturity. Further, many of these alternatives carry default risk.
Bank insured certificates of deposit – these are for people that desire guaranteed safety of their principal and interest. The current rates range from 1% for one year to 2.25% for five years. I would suggest the five year CD.
Fixed annuities – These are issued by insurance companies and are not insured as well as bank CDs, but carry certain state mandated guarantees making them relatively safe. Terms generally extend beyond five years and can reach up to 20 years. Rates are competitive with corporate bond rates for like terms. The people considering these would be the CD investor wanting to lock in a longer term with higher rates. Annuities have tax shelter features making them attractive to those currently in higher brackets that expect to be in much lower brackets when the withdrawals will occur.
U.S. Treasury Bonds – These are for people that want to anchor their portfolio with a guaranteed yield and return of principal at maturity. The rates are lower than for corporates but for many investors the guarantee is more important that the yield. These range from one month to thirty years. Right now the rates are approximately 1.7% for 5 years, 2.9% for 20 year bonds. These are absolutely default free if held to maturity, but are subject to market risk if they need to be sold beforehand.
Corporate Bonds – These are for investors that want the greater security of bonds over stocks. The terms range from 1 year up to over 40 years. As the term is extended the yields will increase. To maximize returns a suggestion is to start a ladder with a 10-year maturity and do it annually or bi-annually for the next 10 or 20 years. A suggested 10 year ladder starting in 10 years with A rated bonds will give you yields from 3% to 4.2% or an average of 3.6%. If you want to start earlier or extend the period, work out the numbers similar to the way I did it in my Feb 25, 2014 blog. This category would include foreign and so-called high yield bonds, but these are not recommended for the average investor, which this blog is directed to.
Municipal Bonds – Same discussion as corporates with lower rates, but usually greater after-tax yields when taking into account their tax free nature and the owner’s tax brackets.
Common stocks – these are not fixed income, carry no guarantee as to dividend or stability of principal, and are subject to the vagaries of the market as a whole and individual performance of the companies. For a well-constructed diversified portfolio, the dividend payout measured in dollars will tend to rise over time as will the stock values. As an example, the present yield on an S&P500 index fund is about 2% and 2.5% on a Dow Jones Industrial Average Index Fund. It is possible to pick individual stocks paying higher dividends than these indexes, but then you are drifting away from what I view as a reasonable market risk. In this category I will include higher yielding REITs and Business Development Companies. This category is for people that are concerned about inflation and/or who are willing to, or need to, assume greater risk.
Preferred stocks – These pay a fixed dollar dividend, but there usually is no maturity date making the principal fluctuate based on the market and in some respects, making it behave similar to a bond fund.
Immediate annuities – These take your money in exchange for a guaranteed payout for the rest of your or your and your spouse’s lives. Using this for a portion of your assets can increase overall yields without sacrificing risk. The tradeoff is that your heirs will not get these funds, but you have to determine which is more important – secure cash flow for the rest of your life or a legacy for your heirs.
Other alternatives – There are more, but those covered here seem like the most common and most assessable choices.
Before deciding how to invest you must consider your needs and goals; attitude toward risk; portfolio size and potential to allocate smaller portions to higher risk choices; whether the interest will be accumulated for reinvestment or be withdrawn for current spending; the type of account the funds are in such as in the investor’s individual name, in a retirement account or annuity.
This is a lot to absorb, and I certainly could keep on going, but will stop for now. Consider what I wrote and discuss with your investment advisor and decide on a sensible program based on your individual situation.
How Can We Help?
