Hungry for higher yields on your certificates of deposit? You might as well ask your banker for a Mediterranean cruise.
With the economy plodding along, banks aren’t lending as much as they used to, so they are less in need of your deposits and less willing to pay high rates to get them. Just look at the recent average yield on six-month CDs-only 2.79 percent.
But you can do better-a lot better. And you can do so without taking on too much risk. After all, this is your sweat-of-the-brow savings we’re talking about, not your latest Lotto winnings. Even in this ho-hum economy there are relatively safe investments that can double the low returns offered on bank CDs, as well as the 2.43 percent average rate on money-market funds.
After interviewing dozens of investment analysts and financial advisers, Money magazine has uncovered six areas of the financial markets providing yields of 6 percent or higher, more than double the return available from six-month CDs or money-market funds.
We’ve also turned up a few selections with yields just shy of our 6 percent hurdle but with good prospects for capital gains in the months ahead.
You can’t go for a higher yield without increasing risk at least a little. But by following the advice here, you can minimize those risks and avoid paying the excessive fees that some brokers are wont to charge. Here are ways to double your returns, from most to least secure:
– Corporate bond funds. Forget long-term corporate bond funds; they’re too dangerous. But there are luscious yields to be found among their short- and intermediate-term cousins, many of which yield more than 6 percent and pose little risk of loss.
Bond analysts typically measure risk by figuring out a bond’s duration. A duration of six years, for example, indicates that a bond will lose about 6 percent of its value if interest rates rise by a percentage point.
Mindful of our low-risk, high-yield objective, analysts who were contacted for this story advised focusing on corporate bond funds with an average duration of less than five years (a fund representative can usually provide information on duration).
– Floating-rate preferred stock. This may sound just like the type of financial twister you promised Mom you’d never touch. But think again. This special breed of preferred stocks has features that make it richly rewarding and relatively safe.
Preferred stock pays high yields, lately averaging more than 5 percent. But when interest rates rise, these preferreds sprout wings and their yield rises along with market rates. That adjustment keeps the value of the preferred from sinking along with fixed-income securities.
The preferreds to look for are those with a “collar”-a feature that limits the maximum and minimum yield it can pay. Usually the collar allows the preferred’s yield to float within a band of seven percentage points or so. Since most of these collared preferreds are now paying close to their minimum yield, that leaves plenty of room for the payout to rise if interest rates should lurch up.
“For someone looking for higher yields but who doesn’t want the risk of long-term bonds, collared preferreds are ideal,” says Richard Lehmann, editor of the High Yield Securities Journal (800-472-2680; $99 a year).
Tax-exempt funds and bonds: If you will be in the new 36 or 39.6 percent tax brackets, make room for munis. Once taxes are figured in, many municipal bonds already easily beat a 6 percent yield from a taxable investment. As tax rates rise, the muni advantage will grow larger still.
There are plenty of muni bond funds to choose from. If you live in a high-tax state, consider a fund that is devoted to bonds from your state. That qualifies your yield for exemption from state and local taxes as well.
For the truly yield-hungry, individual bonds will spare you the annual fund management fee, typically 0.5 percent or more of assets. Tread carefully, though. Many high-tax states are experiencing financial problems, and their bond ratings could be jeopardized.
For investors who don’t face high home-state taxes, or for those who just want to diversify, James Lynch, editor of the Lynch Municipal Bond Advisory (212-663-5552; $250 a year), suggests Texas bonds, which pay higher yields than most other states because Texas has no income tax to spur demand among Lone Star State residents.
– Income funds: While common stocks alone can pose too much risk for short-term savings, an income fund that blends high-yielding stocks with some low-risk bonds can produce attractive payouts without putting your money in peril. The funds offer slightly lower yields than some pure fixed-income investments, but because they own stocks, you enjoy the prospect of capital gains.
Junk bond funds: How can a junk bond fund be safe enough for your savings? To be fair, you have to stretch your definition of safety a bit. But today’s junk market is a world removed from the go-go days of the late ’80s, when corporate takeovers unleashed an avalanche of sometimes worthless debt into the market. Takeovers are now fewer and more financially sound, and thanks to the slow but steady economic expansion, junk bonds are on sturdier ground.
To minimize risk in this sector, Income & Safety publisher Glen King Parker suggests looking for funds that fared relatively well in 1990, a turbulent year for junk bonds when the average junk fund lost 10.4 percent and the worst performer, Dean Witter High Yield, lost a sickening 40.1 percent. Investors should also stick to funds that own the highest-quality junk.
Foreign bond funds: The big bond rally of the past few years may be history here in the United States, but it’s just getting under way in many countries overseas. In Europe, interest rates have hung high until recently, and the rally could last for a year or more, adding chunky capital gains onto the still generous yields.
One risk with foreign bond funds is that U.S. interest rates might rise-or European rates may fall-triggering a runup in the dollar, which would inflict currency losses on American owners of these funds.
Though each of the investment categories reported above warrant consideration in their own right, you might think about combining two or more of them. That will give you rich yields plus valuable diversification.
Says editor John Rekenthaler of Morningstar: “If you can get double the CD or money-market rate with some chance for capital appreciation and moderate risk, that is a nice package.”
We couldn’t agree more.
