INVESTING How You Can Still Earn 10% Safely You don't have to accept the piddling 6% or less offered by money funds and bank certificates of deposit. Here are secure investments that will pay 10% or even more.
(MONEY Magazine) – REMEMBER WHEN income investors could simply put their money in high-quality bonds, sit back and collect nearly 14% year after year? Those happy days are gone. Since last year, yields have been melting away like Popsicles at a Fourth of July barbecue. Many money-market funds and certificates of deposit now pay less than 6%, a smidgen more than stodgy savings accounts do at banks. And after inflation is taken into account, long-term Treasuries yield only 3.6% -- the lowest real return since 1981. Nonetheless, double-digit income investments are by no means extinct -- just harder to find. To flush out the best of the elusive top yielders, MONEY interviewed more than 50 pros at brokerages, mutual funds, money-management firms and investment newsletters. We discovered that while most of today's highest-paying income investments are too risky for typical small investors to consider, there are still a select few that yield a secure 10% or more. You may not have much time left, however, to lock in such high payouts. Most economists expect rates to fall by another half percentage point or so as the recession gives way to a weaker than average recovery later this year. ''By fall, your money fund could be paying less than your passbook account,'' says Edward E. Yardeni, chief economist at C.J. Lawrence, an investment firm in New York City. To avoid that fate, you might want to consider the income investments we turned up. Listed below in nine categories, starting with the safest, they range from bonds and bond mutual funds to real estate investment trusts and convertible securities that also offer potential for long-term capital gains. The experts we consulted recommend that you put as much as half of your fixed- income holdings into a diversifed mix of these top yielders, ideally with no more than 10% to 20% in any single one. Veteran investors may want to skip immediately to the picks, beginning on the facing page. But even experienced hands might benefit from first reading this brief primer on the fine points of income investing: -- YIELD.Ignore the confusing payout statistics often cited by brokers. Focus instead on the numbers that really matter. Among open-end mutual funds, take note of the 30-day SEC yield. It's available by calling the fund sponsor and reflects the fund's prospects far better than the 12-month yield, which is based on income earned over the past year, when interest rates were generally higher. For individual bonds, ask your broker to tell you the yield to maturity and the yield to call. Unlike the more commonly cited current yield on a bond, those two numbers take account of any capital gains or losses you will incur as the issue matures or if it is called (redeemed early by the issuer) at a price higher or lower than you paid for it. If you invest in unit trusts, which assemble portfolios of individual bonds and usually hold them until they mature, ask your broker for the trust's estimated long-term return, which is based on the yields to call and yields to maturity of the issues in the trust's portfolio. Finally, for closed-end funds, rely on the net annual yield. Unlike the current yield on a closed-end, it ignores the capital-gains distributions that boost many closed-end funds' payouts. -- TRANSACTION COSTS. Open-end bond mutual funds that pay double-digit yields almost always nick you with initial sales charges, or loads, of as much as 5% or so, whereas many lower-yielding bond funds carry no sales charge. As a general rule, you should buy load funds only if you need a broker's help in picking them or plan to hold them for three years or more, so that their higher yields will more than compensate for the extra up-front costs.
To avoid high brokerage costs when you buy individual debt securities, plan on investing at least $5,000 per issue and holding your securities until the issuers redeem them. That will reduce your transaction costs to about half a percentage point -- less than the 2% to 4% you will pay to buy or sell smaller amounts or the 1% a year in annual management fees that bond funds typically charge. -- DIVERSIFICATION. Even though almost all of our picks are of investment- grade quality, they could still drop in price because of interest-rate fluctuations or downgrades by credit rating agencies such as Standard & Poor's. So it is important to diversify among several different categories. Adding one or more of them to your income portfolio can boost its yield significantly. For example, an income portfolio split evenly between U.S. Treasuries and high-grade corporate bonds would now yield around 8.8%. If you shifted 20% of the money into a global income fund that holds foreign government issues, you could boost your average yield to 9.1%. And if you moved another 20% into a well-managed high-yield bond fund, you could raise the overall yield to 9.9%.
1 A diversified bond mutual fund People with less than $5,000 to invest can buy a winning portfolio right off the rack: National Multi-Sector Fund (4.75% load; $2,500 minimum investment; 800-356-5535). The fund recently sported a 30-day SEC yield of 9.9%, and for the 12 months to May 1, it delivered a 19.56% total return -- tops among the 101 corporate and general bond funds tracked by Mutual Fund Values, a Chicago newsletter. National's manager Thomas Ole Dial boosts the fund's yield by investing part of its $17 million portfolio in overseas government bonds (10%) and high-yield corporate issues (30%). But he also holds more conservative assets: investment-grade corporate bonds (32%), Treasuries (16%) and cash (12%). While Dial alters the mix to take advantage of fresh opportunities among those sectors, no more than a third of the fund's assets can be invested in high- yield corporate issues -- those rated below BBB by credit rating agencies such as Standard & Poor's. Even risk-averse investors with more than $5,000 might want to include such a fund among their income investments. For example, Houston attorney Robert Haas, 42, and his wife Lisa, 28, pictured at left with their three young children, are so cautious that they keep roughly 80% of their $400,000 portfolio in government securities, high-quality municipal bonds and money- market funds. But in March, on the advice of their broker, they invested about $35,000 in Dial's fund, then yielding 10.2%; since that time, they have put another $10,000 in the fund's shares. ''I'd rather earn 7% and sleep well at night than earn 10% and worry,'' says Robert, whose income fluctuates unpredictably according to contingency fees. ''But this way I can earn around 10% and still rest easy.''
2 Short-term global income funds Since their inception two years ago, funds that invest in short-term debt securities issued by foreign governments, banks and corporations have attracted $12 billion from U.S. investors. Unlike money funds, though, which maintain fixed $1 share prices by keeping their portfolios' average maturities shorter than 120 days, global funds buy issues with maturities as long as two or three years. As a result, the funds can suffer small share-price declines if interest rates tick up. Share prices can also be eroded if the dollar rises against foreign currencies. Managers of these funds diversify among a variety of currencies, however, and use hedging techniques to limit risk. As a result, even in a bad year you are unlikely to lose more than 3% to 5% of your principal. Moreover, such fluctuations are usually temporary and largely balance out over several years. And the 10% yields offered by selected global funds will cushion any price dips. Forecasters expect foreign economies to slow over the next year, which could cause the funds' yields to decline by one percentage point or so. But if you choose a fund with an average maturity of two years, such a decline in rates would produce capital gains large enough to make up for a slightly lower yield. Sheldon Jacobs, editor of the No-Load Fund Investor in Hastings-on- Hudson, N.Y., recommends $30 million Scudder Short-Term Global Income Fund ($1,000 minimum investment; 800-225-2470), which yields 10% and has an average maturity of two years. Most important, the fund has no initial sales charge, while many of its competitors carry loads of 3% to 3.5%.
3 High-yield muni bond funds Most mutual funds that buy tax-exempt issues offer yields of 6.5% or so, equivalent to a taxable yield of 9% to 9.4% for investors in the 28% federal bracket or higher (taxable income of $34,000 or more for married couples; $20,350 or above for singles). You can do even better with high-yield municipal funds that pay 7% or so -- equivalent to a taxable 9.7% to 10.1% for top-bracket investors -- without much additional risk. ''Most high-yield muni funds have no more credit risk than a high-grade corporate bond fund,'' says Ralph Norton, editor of the Municipal Fund Report in Boston. ''They are perfectly suitable for conservative investors.'' Still, not all of the funds are equally safe. To avoid losses from deteriorating creditworthiness or defaults on low-quality munis in the portfolios of some funds, Norton recommends that you stick with two cautiously managed no-loads that offer tax-equivalent yields of around 10% for top- bracket investors: Vanguard Municipal High-Yield ($3,000 minimum investment; 800-662-7447), which yields 7% and holds 73% of its assets in issues rated A or higher; and USAA Tax Exempt High Yield ($3,000 minimum; 800-531-8181), yielding 6.8% with 90% of its assets in bonds with A or higher ratings.
4 Secondhand unit trusts Unlike mutual fund managers, who actively trade the bonds in their portfolios, unit trust sponsors buy eight to 20 issues and then hang on to them until they mature or are redeemed by issuers. Newly formed trusts that hold high-quality corporate bonds yield about 8.5%, but you can get another two percentage points or so if you shop among brokerages for units of previously issued trusts that have been sold back to their sponsors by the original investors. For example, Matthew Monsein, 41, and his wife Jane, 34, pictured above with their 18-month-old daughter Emmie, recently invested $6,600 in Corporate Income Fund Series 213. (The rest of their $60,000 portfolio is mostly in growth-stock funds.) The unit trust, issued in 1985, holds five bonds rated A or higher and two nonrated bonds with credit quality that analysts believe is equivalent to that of issues rated BBB or better. The Monseins bought 11 units with a total face value of about $6,100 and an estimated long-term yield of 10.8%. ''The bonds in the trust are all good-quality issues, so we aren't worried,'' says Matthew, a physician and director of a Minneapolis pain clinic. Secondhand unit trusts are available from five major brokerage firms: Dean Witter, Merrill Lynch, Paine Webber, Prudential Securities and Shearson Lehman Bros. The best bargains include trusts, such as the Monseins', that were issued during the mid-'80s at high yields of around 12%. The bonds in those portfolios are scheduled to mature in 10 years or so, but many are likely to be redeemed within the next one to three years. Since those bonds typically trade at prices slightly higher than their early-redemption prices, the trusts will suffer small capital losses if that occurs. But the bonds' high interest payments will compensate investors for any principal loss and still leave enough for long-term double-digit yields. While trust units typically have original face values of $1,000, you can find them for as little as $500 if issuers already have redeemed some of the bonds in the portfolios. The price you pay includes transaction costs of about 5.5%, but you will face no further charges if you hold a trust until its bonds are redeemed. At that point, you will receive your share of the proceeds. Shearson analyst Michael Brophy recommends trusts that hold only bonds rated BBB or better by agencies such as Standard & Poor's, or issues of similarly high quality. His picks include the Series 213 trust that the Monseins purchased, as well as Corporate Income Fund Series 215, issued in 1985, which holds three bonds rated A+ or higher and two nonrated issues with a credit quality equivalent to BBB. Its units recently traded at $487 each with an estimated long-term yield of 10.9%. Brophy calculates that investors in both trusts will get back about half of their principal over the next two years and the rest by 1996.
5 Closed-end bond funds Unlike more familiar open-end mutual funds, closed-ends, which are sold by brokers, trade on stock exchanges or over the counter. Because the funds' share prices fluctuate with investor demand, they can sell at a premium or a discount to their net asset values, the per-share values of the securities they hold. Many closed-end bond funds now trade at 5% to 10% premiums, but you can still find a few high-quality funds at discounts of as much as 5%. ''Buying at a discount is the surest way to boost your yields without purchasing riskier bonds,'' says George Foot, a partner in Newgate Management | Associates, a Northampton, Mass. investment firm that specializes in closed- ends. Your smartest choices are funds that primarily hold high-grade corporate or U.S. and foreign government bonds. Foot recommends Putnam Premier Income Trust, which recently traded on the New York Stock Exchange at $7.50 a share, a 4.9% discount from its net asset value (NAV), and offered a 12.4% current yield. As with many closed-ends, the fund's dividend includes some capital gains; its net annual yield, however, which reflects only income distributions, is a hefty 10.1%. The fund divides 80% of its portfolio between U.S. and foreign government issues, with nearly 20% in high-yield corporate bonds. In addition, Foot likes Putnam Master Income Trust, which recently traded on the NYSE at $7.88 a share, a 6.1% discount from its NAV, and pays a current yield of 11.8%; the net annual yield is 10.5%. The fund divides 70% of its assets between U.S. and foreign government issues; the rest of its assets are in high-yield U.S. corporate bonds.
6 Investment-grade corporate bonds Top-quality corporate issues with AAA credit ratings yield about 8.6%, down from 9.6% last August. But with the help of a diligent broker who specializes in corporate bonds, you can still find yields of 10% among investment-grade issues rated BBB. Jack Saunders, manager of the USAA Income Fund, recommends Occidental Petroleum 11.75s of 2011, which recently traded on the NYSE at $1,100 per bond, for a 10.5% yield. Since the death last December of the company's flamboyant former chairman, Armand Hammer, successor Ray R. Irani has embarked on a restructuring program to reduce Occidental's $8.1 billion long-term debt by $3 billion over the next two years. Meanwhile, the company's $1.5 billion annual cash flow from operations easily covers its $960 million annual interest payments. The bonds can be redeemed in 1996 at $1,048 each -- 4.6% below their current price. Saunders maintains that an early call is unlikely; and even if it does occur, the issue's yield to call would still be a handsome 9.9%. James Caywood, president of Caywood-Christian Capital Management in San Diego, recommends MCI 10s of 2011, rated BBB- by Standard & Poor's and recently traded over the counter at $1,020 each, with a yield to maturity of 9.9%. The firm's $2 billion annual cash flow dwarfs its $250 million annual interest payment on long-term debt; as a result, MCI can afford to invest $1.1 billion this year to improve its long-distance network. &
7 Convertibles These securities are bonds or preferred stocks that can be converted at the owner's option into the issuer's common shares. Some convertibles offer yields of 6% to 8%, and their prices will rise or fall nearly as much as their common shares do. But income investors may prefer convertible issues with yields of 10% or higher, which trade more like bonds. Such convertibles usually rise only 20% to 30% as much as their underlying common stocks do -- but suffer only around 15% of any losses. If you hold such a convertible for several years, even a modest 6% annual gain in the value of the stock can boost your ultimate total return by roughly three percentage points annually. Michael Rosen, an analyst at Fielding Management Co. in Rochester, N.Y., favors two investment-grade convertibles that yield more than 10% and could pick up another two or three percentage points annually in capital gains. The first, BBB-rated Union Carbide 7.5% convertible bonds of 2012, which recently traded on the NYSE at $770 per bond, offers a 10.2% yield to maturity, including gains that investors would realize when the bond matures at its face value of $1,000. At its current price, the convertible would probably share in 20% of any gains in Union Carbide stock. Rosen expects that as the firm's depressed earnings recover with the economy, the stock's price could climb by 8% annually over the next five years; that would boost the convertible's annual total return to 13%. Rosen also likes BBB-rated Ogden Corp. 6% convertible bonds of 2002, with a recent yield to maturity of 10.5%. He thinks the company's stock price could climb from its current $18 to at least $26 over the next four years, delivering an annual total return of 12% on the convertible.
8 High-yield corporate bond funds These funds, which typically invest in corporate junk -- bonds rated below BBB -- have delivered average returns of 18.6% so far this year. Still, in light of the 15% to 20% losses registered by some of the funds in 1990, you have to choose among them extremely carefully. Some analysts who advised investors to shun all high-yield funds during the past two years now say that conservative investors might consider a modest commitment -- say, 10% to 20% of their fixed-income holdings -- to a fund that buys the strongest high-yield issues. ''Yields of 12% to 13% on the higher- quality funds more than compensate for their risks,'' says Thomas ! Steffanci, director of fixed-income investments at Fidelity Investments in Boston. Among such funds, consider two no-loads suggested by newsletter editor Sheldon Jacobs: Vanguard High Yield Bond Fund ($3,000 minimum investment; 800-662-7447) recently yielded 12.8%, with 67% of its portfolio in bonds rated B or BB and 23% in bonds rated BBB or better. The fund has posted a total return of 13.8% since Jan. 1. Nicholas Income ($500 minimum investment; 414-272-6133; 10.9% yield) holds 37% of its assets in B-rated bonds, 30% in BB-rated issues, and about 10% in investment-grade bonds with BBB ratings. Including capital gains, the fund has returned 12.3% so far this year.
9 Real estate investment trusts These companies, known as REITs for short, trade on stock exchanges or over the counter. So-called equity REITs invest in commercial or residential properties; other REITs hold mortgages. The equity type are potentially the most profitable, but only a few of those that offer double-digit yields are likely to sustain their payouts as the slide in commercial real estate continues for two or three more years. ''With tenants for shopping centers and office space in short supply, many equity REITs will have trouble filling space and raising their dividends as their current leases expire,'' says real estate analyst Jon Fosheim of Green Street Advisors, a REIT research firm in Newport Beach, Calif. The wisest choices include financially strong health-care REITs that invest in nursing homes, hospitals and other facilities. The tenants are typically committed to leases as long as 10 years, compared with three to four years for other equity REITs. Moreover, tenants are generally responsible for maintaining the properties, which reduces the REITs' costs. For conservative investors, Fosheim recommends Meditrust (NYSE, $23.75; 10% yield), the largest health-care REIT, which owns 117 properties. He expects rising rents to boost the dividend by 5% to 6% annually for the next two years. By taking slightly more risk, as did Daniel Fowler, 40, and his wife Marcia, 33, of Stamford, Conn., you can earn more with a smaller REIT. The Fowlers, pictured here, have about half of their $30,000 retirement portfolio in Health & Rehabilitation Properties Trust (NYSE, $11; 10.9% yield), which owns interests in 42 properties. John Hindelong of Donaldson Lufkin & Jenrette in New York City, who currently recommends H&R Properties Trust, expects the REIT's cash flow and dividend to increase by 5% to 10% annually over the next several years. And indeed, the Fowlers' big bet has delivered excellent returns so far: they purchased their 1,500 shares over the past three years at an average price of about $8.50 each. ''We bought the REIT for the yield, but it's also been a great stock,'' says Daniel, a sales manager for a manufacturing firm. Still, don't copy the couple's risky strategy by investing the bulk of your assets in this REIT -- or any other single security, no matter how promising. Why risk double-digit losses in one investment when you can diversify among several and get safe, double-digit yields?