Income Investors: How to Boost Yield (a Bit) Without Adding Risk
But remember the junk bond and real estate debacle of a decade ago
As 2019 winds down, a series of Federal Reserve interest rate cuts has once again left income investors hurting. Online savings accounts pay a measly 1.7% on average, and the 10-year Treasury note yield is below 2%.
“Savers are getting penalized,” Janet Yellen, former head of the Federal Reserve, recently acknowledged.
But an even bigger penalty would be letting your frustration lead you into making risky tradeoffs in an effort to earn more income in 2020. Stretching for yield is usually a bad idea, as those higher-yielding instruments carry with them increased risk. And retirement planning requires a long-term mindset.
Instead, a few income strategies to consider:
Get paid more for saving at an online savings bank. If your savings are still parked at a traditional “brick-and-mortar” bank or credit union, you’re likely earning next to nothing. The average yield on savings accounts from old-school banks is less than 0.25%. Plenty of online banks (just do a web search for “high-yield online savings accounts”) currently pay 1.7% or more. Online bank and credit unions have the same federal guarantees as brick-and-mortar banks.
Don’t worry, this is not a huge hassle. Keep your checking account right where it is – who wants to set up new direct deposit and bill pay? All you need to do is link that account to a new online savings account; with just a few clicks, you can easily transfer money between the two.
Check where your cash is parked in your brokerage account. If you trade often, and don’t automatically reinvest the money, your brokerage parks your money in a cash “sweep” account. Some brokerages, such as Vanguard and Fidelity, use a money market mutual fund as the default sweep. But many now use a low-yielding bank savings account as the default. The brokerage pockets the difference between the low interest it pays clients in the bank account, and the higher yield it earns on investing the money elsewhere.
In December, the average brokerage sweep account paid 0.13% according to Crane’s Money Fund Intelligence. The average yield clients could earn by moving their cash into a money market mutual fund offered by their brokerage was more than 1%.
For example, Schwab sweeps client cash into a bank account that currently pays as little as 0.06%. But alert investors (or their advisors) can override the default and move the money into a higher-yielding money market fund; for example, in late December, the Schwab U.S. Treasury money market fund paid more than 1.35% interest.
Before you say that’s not worth it, perhaps frame it as an optional penalty you are willing to pay. Using Schwab as an example, $10,000 earning 0.06% generates just $6 in interest. If it’s parked in the Treasury money market it pays $135. That seems like plenty of reason to periodically do your own sweep out of the default account and into a better deal, whether it’s a money market fund or reinvesting in stocks or bonds.
Remember why (and when) Treasuries rock. It is definitely harder to love U.S. Treasuries right now, with yields of less than 2% for bills and notes that mature in 10 years or less. Yet, Treasuries are likely the most valuable part of your long-term investment portfolio. When stocks fall, Treasury bonds offer the best protection, rallying more than any other type of bond. Owning Treasury bonds is the ballast that can keep you committed to stocks in a bear market.
During the 2007-2009 bear market, when U.S. stocks fell more than 50%, a portfolio of intermediate term U.S. Treasuries gained more than 16%; that was more than double the return for “core” bond funds popular in retirement plans that own a mix of Treasuries, corporate bonds and mortgage-backed securities.
Stick your neck out with eyes wide open. If you are determined to earn more income, there are indeed investments that earn more than 2%. High-yield U.S. corporate bond funds and exchange-traded funds yield more than 4% these days. Emerging market bonds yield near 5%. Funds focused on real estate yield close to 5%. Before you fall for the temptation of those markedly higher yields, keep in mind that none of those investments behave like a Treasury or core bond when a stock bear market hits. In the 2007-2009 bear market, emerging market funds lost more than 10%, high-yield “junk” funds lost more than 20% and real estate investment trusts more than 60%. That’s a whole lot of downside risk for a bit more yield today.
If you’re not deterred, you might consider taking money from the stock side of your investment portfolio to invest in these riskier income investments. You don’t want to swap out lower risk bonds for these higher risk investments that behave like stocks in a downturn.