By gradually lifting short-term interest rates, the Federal Reserve has made it easier for retirees to get steady investment income while taking less market risk.
But only up to a point. Because rates remain low by historic standards, it still isn’t possible for retirees to base their investment strategies entirely on cash or other relatively safe sources, investment professionals say. Instead, they need to own some combination of bonds or bond funds, dividend-paying stocks and other noncash assets to get both cash flow and the appreciation they’ll need to make it more likely they won’t outlive their assets.
In creating that mix, it is also important to consider the current financial climate, which has grown riskier as the Fed has stopped pumping as much money into financial markets and the economy. Retirees in particular should make sure they are using some conservative income strategies—such as owning high-quality, dividend-paying stocks—that will provide a dependable source of cash flow regardless of how the economy fares during the next phase of the market cycle, professionals add.
For those who want to review their portfolio mix and incorporate some more conservative income strategies, here are some suggestions from financial advisers.
Hold more cash, but with a better yield
Besides being key from a spending perspective, a cash stash also can figure into an overall portfolio strategy, says Tom Stringfellow, president of Frost Investment Advisors, San Antonio. Keeping 15% or a little more in cash may soften the impact of gyrations in the equity area of a portfolio, making it easier for an investor to ignore volatility and stick with the plan, he says.
Many high-yielding bank money-market accounts currently yield under 2.5%, which is less than an investor might get from bonds or some stock dividends. To do better, investors might consider putting cash that isn’t needed immediately into a bank certificate of deposit. CDs pay more than most money-market accounts, but often levy a penalty if a saver withdraws funds before maturity.
Eighteen-month CDs, which have yields nearer to 3%, are the best right now from a term and rate standpoint, says Jeff Carbone, managing partner at Cornerstone Wealth, in Charlotte, N.C. He suggests creating a ladder, buying a new 18-month CD every six months and reinvesting the proceeds as each matures. That enables an investor to tap higher CD rates while providing cash that can be spent or reinvested whenever one matures.
Buy high-grade corporate bonds
Savings rates will decline again as the economy eventually cools and the Fed starts lowering rates again. But short-maturity corporate bonds probably will continue to generate decent yields, says Jim Barnes, director of fixed income at Bryn Mawr Trust. While their principal value will rise or fall on news affecting an issuer or the broad bond market, such bonds can offer a relatively conservative play if they carry investment-grade credit ratings, triple-B or higher, Mr. Barnes says. Many yield north of 3% now.
He cautions against loading up on lower-rated, so-called high-yield corporate bonds, though. While they yield much more, their prices can tank in scenarios where investors are stampeding from risk. In last year’s fourth quarter when stocks plunged, the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) lost about 5% in price.
Vanguard Short-Term Corporate Bond (VCSH), an investment-grade ETF that holds Morningstar Inc.’s second-highest silver rating, charges 0.07% in annual fees. Morningstar gives its next-highest rating of bronze to the SPDR Portfolio Short Term Corporate Bond ETF (SPSB), which also charges 0.07% in fees. Both yield nearly 3%.
Some advisers believe it is less risky to use active managers in the corporate bond space. One with Morningstar’s highest gold rating is Dodge & Cox Income Fund (DODIX), which yields about 3.4% and recently held more than 40% of its portfolio in corporate bonds.
Look for alternatives
Preferred shares rank in between common stock and bonds in the asset spectrum with regard to balance between returns and safety. They trade like stocks, but make regular payouts like bonds. And when companies make payouts, holders of preferred—as the name suggests—get preference over holders of common stock.
The yields on preferred shares can be attractive. The iShares Preferred & Income Securities ETF (PFF), with about 49% of its portfolio rated triple-B, yields around 5.3%. Invesco Preferred ETF (PGX), meanwhile, whose portfolio predominantly comprises low-investment-grade securities rated triple-B, generates about 5.4% in yield.
Although preferred shares pose lower risk than some other income plays, they aren’t without risk, says Doug Cohen, a managing director at Athena Capital Advisors, Boston. A key concern would be a big rise in long-term yields—those rates that tend to be influenced more by fear of inflation than by modest changes in Fed policy. If long-term rates go up, principal values will drop, Mr. Cohen cautions.
The argument for equities
If the economy and corporate profits grow more slowly, stocks certainly won’t boost portfolios as much as in recent years. But only equities can give investors a reasonable cushion over U.S. inflation, which is broadly around 2% and may be higher for older Americans because of the escalating costs of items such as pharmaceuticals. “It’s important to get returns that clear the inflation rate so people aren’t being robbed of purchasing power,” says Hans Olsen, chief investment officer at Fiduciary Trust Co., Boston.
Financial-data provider CFRA gives high ratings to both Vanguard High Dividend Yield (VYM) and iShares Core High Dividend (HDV), ETFs that both generate yields above 3% by investing in blue-chip dividend payers such as Johnson & Johnson (JNJ) and Exxon Mobil Corp. (XOM).
Todd Rosenbluth, who heads ETF and mutual-fund research at CFRA, says that because of the bigger income component these higher-yielding ETFs contain, they also decline less at times, like last fall, when stocks are tanking.
People who don’t care as much about an income stream, Mr. Rosenbluth adds, instead might choose an ETF that owns companies that raise their dividends consistently. Such ETFs have lower yields—maybe around 2%, compared with 3% or more for VYM and HDV—but the companies in their portfolios build capital and increase their dividends over time.
“If you are concerned that the market is likely to weaken, the higher-yielding dividend strategies are more appropriate” than dividend-growth plays, he says.
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