In these days of meme stocks and fantastic returns on crypto or big tech, there is a class of investor who is often forgotten: those that look to their investments for income. It is, however, a large and growing pool of people. Company pensions began to decline when 401ks were introduced in 1978 and started to gain in popularity after a 1981 change to the law, so we are currently seeing the first generation of retirees for whom yield on saved money is the only source of income beyond social security.
So far, it isn’t going well for them.
They did as they were told and invested consistently in a 401k. They paid the fees for decades, rode out the market’s ups and downs and now have a pool of money from which they have to derive the equivalent of a pension. However, back when they started, calculations were based on an expected yield of six, seven, or even eight percent from “safe” investments in Treasuries and investment grade bonds. That looked conservative back then but looks simply ridiculous now, with the 10-Year yield stuck firmly below 1.5%. Add in inflation at levels that hasn’t been seen for over a decade, even if it does turn out to be transitory, and a lot of people of retirement age have a problem.
The answer is to look beyond bonds for yield. That, however, is inherently risky, because yield on investments is essentially a reward for risk. The higher the yield, the greater the risk to your capital, and capital risk is something that retirees should avoid, or at least try to minimize.
The classic way to mitigate risk in a portfolio is through diversification, and that applies to things bought for yield as much as for appreciation. Spreading your money between investments in different industries and different types of yield instruments doesn’t remove risk, but it does smooth out the typical bumps in the road over time. With that in mind, here are three things that can be used to increase the one or two percent yield that you might expect to get from bonds, but which are diversified enough when taken together to not add tons of risk to your overall portfolio.
Enbridge Inc. (ENB): Energy is a traditional sector in which to look for yield and, even though there are obvious long-term concerns about oil related businesses, it is a good place for retirees to start. After all, if fossil fuels are replaced completely, is it likely to be in the next twenty years or so that forms the time horizon for all but the luckiest of retirees? Probably not and, in the meantime, you can get a decent yield from companies like Enbridge with strong free cash flow and at low enough P/Es that capital appreciation isn’t out of the question.
ENB is a Canadian pipeline and natural gas utility company that pays out like the Master Limited Partnerships (MLP) that are common in the pipeline business, but which is structured as a regular corporation, so doesn’t have the more complex tax reporting requirements of an MLP. The projected 1-year yield on ENB, based on anticipated quarterly dividends, is 7%.
AGNC Investment Corp. (AGNC): AGNC is in another traditionally popular category with yield seekers. It it is a real estate investment trust (REIT). Like MLPs, REITs are what is known as “pass through” entities, meaning that at least 90% of their income has to be passed through to shareholders. However, unlike MLPs, the income investors get from them is reported on a basic 1099-DIV rather than the more complex K1 used by partnerships.
Where they differ from most REITs, however, is that they don’t invest in property, they invest in mortgages. They typically buy bundled mortgages on which the principal and interest payments are guaranteed by the government through various agencies. Even with that level of guarantee, however, AGNC currently offers a forward yield of 8.93%.
SPDR Blackstone Senior Loan ETF (SRLN): The third choice is a much less well-known category of investments for yield, senior loans. These are bundled bank loans that are the first thing paid in the event of bankruptcy, so they are in theory safer than bonds. However, they tend to be issued to companies with weaker credit, so there is an inherent risk that leads to decent yields.
Investing in senior loans through an ETF such as SRLN has the added advantage of offering a lot of diversification within itself. The top sectors in terms of the fund's holdings are business services, semi-conductors, and healthcare, followed by finance, transportation and telecoms. That is why, even though the yield of 4.6% is a bit lower than the other two picks, SRLN makes my top three investments for yield.
There is one common risk in investing for yield that cannot be avoided: If interest rates on Treasuries were to increase significantly, the value of all of the above as yield instruments would decline on a relative basis and their prices would drop. That, however, is unavoidable in anything that pays interest, so unless you have enough saved to live off of the one or two percent you can get from traditional bond investments, it is something you just have to live with. If you allocate part of your portfolio to the above, though, the 6.84% return from an equally weighted investment in ENB, AGNC, and SRLN certainly makes it worthwhile.
* Two disclaimers are needed here. First, I own AGNC. Second, I am not a tax advisor, so any tax related decisions about your investments should be discussed with a qualified professional.
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Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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