Nellie Huang, of Kiplinger's Personal Finance, discusses a variety of ways for investors to generate income, without buying common stocks. Here, she looks at bond funds and ETFs that are focused on munis, intermediates, floating rate, junk, and preferreds.
Steven Halpern: Joining us today is Nellie Huang of Kiplinger’s Personal Finance. How are you doing today, Nellie?
Nellie Huang: I’m great. Thanks for having me on the show.
Steven Halpern: Well, thank you for joining us. Your latest featured article for Kiplinger’s focuses on ideas for generating income, and what was particularly interesting about that focus in your article is that you looked at income ideas that do not involve common stocks, and you move from the lower end of the yield spectrum all the way to higher yielding products.
So, let’s begin at the low end, where you looked at municipal bonds. Who should be interested in that market and what ways would you suggest for somebody to invest in?
Nellie Huang: Muni bonds, actually, they yield about 1.9% these days but, actually, on a tax equivalent basis, which you know because the income generated from these bonds is not subject to federal—and sometimes they’re also state and local tax-free—the actual tax equivalent yield is much higher.
So, these days, you can get about what a ten-year Treasury would pay on a ten-year high-quality muni bond. So anyone in the 28% Federal income tax bracket and higher should look at these bonds if they’re investing money in a taxable brokerage account.
Steven Halpern: Is there a particular fund that you like in that area?
Nellie Huang: Our favorite tax-free bond fund is Fidelity Intermediate Municipal Income (FLTMX:US). Fidelity’s bond division is very conservative, which I like.
It’s comforting to me to know that they’re going to take less risk to invest my bond money and this bond fund has done very well in down periods. They’re good at, kind of, more stable returns.
Steven Halpern: Now, in the intermediate-term, investment-grade bond area, is there a favorite you would like there?
Nellie Huang: I’m going to mention two mutual funds. Fidelity Total Bond (FTBFX:US)—again, this is a diversified fund. It holds a mix of different bonds, including high-grade corporate bonds, government bonds, and mortgage securities, and it is yielding about 2.8% right now.
And there is also DoubleLine Total Return (DBLTX:US). It doesn’t hold a diverse mix of bonds. It holds mostly mortgage bonds, but the yield on that fund right now is about 4.5%.
Steven Halpern: Okay, now for a slightly higher yield, along with some protection against rising rates, you suggested investors consider floating rate bonds. Could you expand on that?
Nellie Huang: Yes, they’re actually bank loan funds. These are securities that banks make to companies that have slightly troubled credit history, so they can’t just issue bonds on the bond market but, because they’re below investment grade, they also have these variable rates.
|pagebreak|They move in step with the market, so they reset about every 30 to 90 days, if rates rise, and a lot of people think rates will rise.
You know they’ve been saying that for awhile, but they will rise eventually and these bond funds should do well because the bonds will reset as rates rise.
Investors can consider Fidelity Floating Rate High Income (FFRHX:US) or PowerShares Senior Loan Portfolio (BKLN).
Steven Halpern: A little higher on the yield curve is what’s referred to as junk bonds, a name that scares many investors away. Can you explain what junk bonds are and how somebody should invest in that area?
Nellie Huang: Junk bonds are high yield bonds. These are bonds that are issued by companies with credit ratings that are rated BB or lower, so it’s not investment-grade, it’s below investment-grade.
This means that these companies have a higher potential to default on their loans. But I will add that, these days, the default rate is at a 20-year low and the US economy is improving.
And when the US economy improves, the fortunes of all companies kind of improve because there is higher demand, they’re selling more, earnings improve, so the risk of default is a lot lower in an improving economy.
That’s why, though junk bonds are riskier than investment grade bonds, this is probably a good time to own them.
Steven Halpern: Now, is there a particular fund that you would suggest investors consider?
Nellie Huang: I like USAA High Income (USHYX:US). It’s yielding about 4.7 right now and, again, they are a little bit more conservative in their approach.
I mean, they still take a little bit of risk because it’s a junk bond fund, but it’s not a real “way out there” junk bond fund. And there is an ETF that I like too and that’s the SPDR Barclay’s High Yield Bond Fund (JNK).
Steven Halpern: Now, finally, you suggested that income investors consider preferred stocks, which are really a hybrid between stocks and bonds. Could you explain the attraction of preferreds?
Nellie Huang: Preferreds—it’s called a preferred stock—but it really behaves more like a bond, partly because they pay these higher dividends than a common share would pay.
That does make them a little bit more sensitive to interest rate moves and there are a couple of other risks involved.
They’re mostly issued by financial firms, banks, so any fund that you invest is going to be heavily invested in that sector but they do pay these fixed dividends and the typical yield is about 6.7%, which is pretty high. That’s a pretty good yield.
Steven Halpern: Rather than somebody buying individual preferred stocks, you suggest a preferred stocks fund. Could you tell us about that?
Nellie Huang: Yes, instead of kind of betting on one company, you could buy an ETF. We like PowerShares Preferred (PGX) and you get a little bit more diversification because it holds about 70 different preferred shares and that yields 6.4%.
Steven Halpern: Well, we really appreciate you taking the time today and remind our listeners that Kiplinger’s Personal Finance is out on the newsstands in case people want your full article with additional income investing ideas. Thank you for joining us.
Nellie Huang: Great, thanks for having me.
