Times are getting harder and harder for folks simply looking for income from their investments. Ignore growth or appreciation. Just income.
Interest rates are down across the board because inflation is down and the demand for deposits and borrowed money is down. In fact, the outlook for inflation is so flat, that the Social Security Administration recently announced there will be no cost-of-living adjustments to monthly benefits checks in 2010 and maybe not in 2011, as well.
So the pressure on anybody looking for substantial low-risk interest or dividend income will only increase in the months and maybe years ahead. This challenge applies to everybody, retirees and non-retirees alike.
In our advisory practice, we have come up with a practical solution to this challenge. The recipe calls for four ingredients: bank CDs, high-yielding stocks, investment-grade corporate bonds and preferred stocks. Sound daunting or confusing? Here are the details.
First, keep in mind this recipe is designed to satisfy the demand for low-risk income. If you are inclined toward high-yield bonds or other lower-quality investments, you could increase the yield (interest and dividends), but most folks today are looking for predictability and stability. This recipe may work for you.
The object of this recipe is to give you an average 4 percent or more of annual yield. Some investments will produce more and some less. Part of the way we manage risk in this recipe is to spread the money across multiple investments and the four investment types.
The proportions are two parts bank CDs and one part each of stocks, bonds and preferreds. For example, if you have $25,000, $10,000 would be in CDs and $5,000 would be in each of the other three investment types.
Also the maturities for the CDs and the corporate bonds would be laddered out over the next five years or so. This means that among your CDs and bonds, you have one CD and one bond mature in one year's time, another pair in two years and so on. When you buy these investments, you buy the maturity date, not the yield or interest rate. If you become seduced by a higher interest rate, say three years out, and you put all of your CD allocation into that one certificate, you will subject yourself to reinvestment-rate risk (which is a bad thing). Remember we want a portfolio as risk-free as possible.
At today's rates, you might expect to get an average yield of 2.4 percent from laddered CDs, over 5 percent from investment-grade and laddered corporate bonds, over 4.5 percent from high-dividend-paying stocks with strong balance sheets, and over 6 percent from preferred stocks. We advise clients concentrate their preferred-stock investments in utilities. When this recipe is complete, you will have a low-risk portfolio with an expected yield a little over 4 percent.
Bear in mind there is no such thing as a portfolio without any risk. There are so many risks in the investment world that to solve for one invariably subjects you to another. For example, if all of your money were in CDs for a couple of years and you were honest about inflation and taxation, your money would lose purchasing power. To solve for the risk of loss of purchasing power, you may have to forfeit a measure of absolute preservation.
The market is poised right now to deliver some relatively low-risk interest and dividends. That may just be the right recipe for you right now.
