Searching for Yield
One often asked question is, “What investments can give me higher interest or dividends than the paltry market averages?” Here are some thoughts you might consider:
Of course, a lot depends on your age and the amount and kind of investments you hold now. Younger people and those with substantial savings are concerned with growth, not interest rates. Older people with relatively little investments that are highly dependent on Social Security have lots of concern with interest rates because of the large part of their savings that are in fixed income investments.
No matter what your investments may be, if you are older, the first question to ask is whether you can increase your Social Security payments by starting later. This is absolutely the best way to increase “yield,” because it’s impossible to find a government guaranteed return better than Social Security offers. Those who have already started getting Social Security before age 70 should look into what it would take to pay back previous Social Security income and start again. There is no insurance company that could afford to offer the additional amount afforded by an increase in Social Security payments.
The next most fundamental thing is to look at your home as an investment. Can you downsize to provide additional liquid investments? A home, particularly an overly large one, incurs large property taxes in most areas and takes a lot of income to maintain. Further, it can make it difficult to consider leaving for employment elsewhere or to be more conveniently located to children who might help you when older.
Then we get down to examining the investments themselves. What’s really important is safety, liquidity and total return, not interest or dividends alone. The ultimate safety net is with federal government bonds, federally insured Certificates of Deposits (CDs) as well as bank savings accounts and likely money markets. The easiest federal bonds to buy are Savings I and E Bonds. Treasury Inflation-Protected Securities(TIPS) are another federal bond that you can buy from a broker, or more cheaply on the internet from www.treasurydirect.gov. After those come immediate annuities from highly rated insurers. Then come municipal and corporate bonds. At the bottom of the safety pole are volatile stocks. Well there are things that are worse safety risks such as hedge funds, derivatives, options, and those Exchange Traded Funds (ETFs) that use high risk investments based on narrow sectors or thinly traded issues.
Liquidity is very important for those who need regular income from their investments. One of the most illiquid investments is a partnership. Sometimes these are even difficult to give away. Another illiquid investment is a time-share—where you might actually have to pay someone to take it off your hands. Then come rental real estate and your home. You can own real estate that is liquid if you invest in Real Estate Investment Trusts (REITs) which are sold on the stock market.
It makes a big difference whether the money is in a taxable or deferred-tax account like an employer’s savings account or an IRA. That’s because of age limitations and required minimum distributions (RMDs) for deferred-tax accounts. The IRS specifies RMDs which turn out to be the average life-expectancies plus about ten years. Unless you are very likely to live well into the hundreds, you likely can withdraw more than the RMDs safely. For those who feel they can get a higher after-tax return than inflation, a rough rule of thumb might be to base your withdrawal rate on the government’s RMD less the number ten. That’s because you will be dividing last year’s remaining balance by a smaller number thereby giving you a larger withdrawal. In a deferred-tax account you have the necessary liquidity, and you have the capability to go for total return, not just high interest rates.
Some deferred-tax accounts offer a Guaranteed Income Fund(GIF). In Boeing’s 401(k), they offer a GIF called the Stable Value Fund which has much higher interest rates than a money market fund but lower than a bond fund. However, a bond fund may lose the value of its principal when interest rates go up, and a high-yield fund, otherwise known as a junk bond fund, can really suffer.
It’s for that reason that I like to recommend buying the individual bonds instead of bond funds. Bond funds have had higher total returns than the interest they earn as market interest rates declined over the past few years. But that situation is likely to reverse. Mutual funds have liquidity, but not stability unless they are money market funds. With the exception of Savings Bonds, it’s best to hold bonds to maturity to be sure that you get your full principal back. If you hold the bonds yourself, you have to ladder them to ensure that the maturity dates are spread through successive years.
I like immediate annuities as a good substitute for yield. With these you plunk down your money and start getting monthly payments that last until you or your spouse dies or some other specified time limit. There are two risks here: (1) the insurer defaulting, and (2) inflation. To beat the former you should only consider the highest rated insurers. To beat the latter, you can either buy inflation-adjusted immediate annuities (which are hard to find and have lower payments initially) or make sure that you don’t spend all of the fixed payments and save a little to provide income later in life as inflation degrades the purchasing power of those fixed payments.
The amount I feel that is prudent to spend from any fixed income source with fixed payments is the after-tax amount multiplied by your age divided by 100. That means that a 70 year-old person would only spend 70% of a fixed payment from an immediate annuity. She would have to save the other 30% for the future. That’s effectively what those insurers do when they issue an inflation-adjusted immediate annuity and the reason that you get a lower payment initially.
Most people who are worried about getting yield in the form of interest are in a low tax bracket, but immediate annuities have interesting tax benefits if not within a deferred-tax account. If you buy an immediate annuity with after-tax dollars, only a part of your monthly payments are taxable. The remainder is a return of the principal you invested. That tax benefit ends when the principal is all returned to you. Unfortunately that’s late in life (at what the insurer considers your life-expectancy at the time you purchased the policy) when having 100% of your monthly payment suddenly subjected to income tax.
CDs, bonds and immediate annuities should all be laddered. That means that CDs and Bonds should have different maturity dates and maybe even different sources to help protect against default. Immediate annuity laddering means that you use only a small part of your savings for the first purchase, wait another year or so, buy another small part, and so on. That’s because the payment amount from an immediate annuity will be larger if you are older because the insurer expects that fewer payments will be needed. However, the immediate annuity specified payments are determined on the basis of the insurer’s perception of future interest rates at the time of the purchase. That means that your contract payment values may be set at a lower amount when prevailing interest rates are low.
So the search for higher yield can be quite complicated. In many cases, it’s worth the small amount required to pay a Certified Financial Planner, CFP, to get the result that’s best suited for your age, your current investment balances in deferred-tax or other accounts, safety, prevailing market rates, need for liquidity, and other personal factors.
Henry K. (Bud) Hebeler