Description

With Treasuries paying rates in the low 2% range, investors have to search far and wide to find better yields.

Historically, many retirees and preretirees have looked to their portfolios as a potential source of income. In the current environment, finding these sources is no easy task. Ten-year U.S. Treasury bonds yield only 2.2%, and dividend-paying stocks within the S&P 500 are yielding 2.5%.1

But there are opportunities for higher yields that investors may want to consider. Higher yields can mean greater risk, so it is important to understand risk and potential return with any investment.

Potential Sources

When looking for yields that currently exceed U.S. Treasury securities, you may want to review the following:

  • As of September 30, 2011, corporate high-yield bonds, as measured by the Merrill Lynch High-Yield Master II Index, generated yields of 9.54%. Keep in mind that the yields of some corporate high-yield bonds compensate investors for default rates that historically have been higher than the broader fixed-income universe.2
  • Higher-yielding sectors within the S&P 500 have included Telecommunication Services, which yielded 5.59% as of September 30, 2011, and Utilities, which yielded 4.27%.3 Standard & Poor’s believes that expense control and broadband growth will support dividends for the Telecommunication Services sector. For Utilities, Standard & Poor’s anticipates that higher revenue among electric utilities and expanding gross margins for gas utilities will cause the sector’s dividend yield to be maintained.
  • Emerging market sovereign debt, as measured by the Merrill Lynch Emerging Market Sovereign Bond BBB U.S. Dollar Index, yielded 4.65% as of September 30, 2011. Emerging market debt provides exposure to markets where economic growth currently exceeds the developed world while avoiding troubled European markets.4

Yield and Your Portfolio

The following tips may help you evaluate higher-yielding investments at a time when finding yield remains a challenge.

  • Review an investment’s exposure to risk as well as its potential return. High-yield bonds historically have experienced higher default rates than investment-quality issues. Keep in mind that bond prices decrease when interest rates rise, opening bondholders to downside risk if inflation increases and market interest rates rise from their current lows. Holding a bond to maturity eliminates this secondary market risk.
  • Diversify sources of yield. Relying too much on one or two income-oriented securities can leave you exposed to unanticipated changes in the financial markets.
  • Consider your asset allocation. Since yield is available from both stocks and bonds, you may be able to create a high-yielding portfolio within the framework of your desired asset allocation. Within a stock allocation, equities within the S&P 500 Dividend Aristocrats have increased dividends every year for at least 25 years. Municipal bonds may present tax benefits for fixed-income investors.5

The variety of yield sources available presents opportunities to craft an income-generating portfolio suitable for many different risk profiles and time horizons.

Source/Disclaimer:

1Yields are as of September 30, 2011. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, they offer a fixed rate of return and fixed principal value.

2Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer. They may not be suitable for all investors.

3Investments in specialized industry sectors have additional risks, which are outlined in the prospectus.

4Emerging markets are generally more volatile than the markets of more-developed foreign nations, and therefore you should consider this increased market risk carefully before investing. Investors in international securities may be subject to higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities.

5Municipal bonds are federally tax free, but other state and local taxes may apply.

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© 2011 McGraw-Hill Financial Communications. All rights reserved.

December 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by D3 Financial Counselors, a local member of FPA.