Maximize your investment income

By Bob Moeller
WEAC Member Benefits

April 2007

Financial Planning Seminars
Achieving Financial Independence

It is hard to invest for income these days.We are experiencing an unusual interest rate environment called an inverted interest rate curve. What this means simply is that longterm interest rates are lower than short term.As I am writing this, a onemonth treasury bill is paying a 5% annual rate.A one-year treasury bill is paying 4.85%, and a 30-year is paying 4.67%. My daily interest money market accounts are paying 5.1%.All your short-term investments should be yielding around 5% also.

Things are further complicated by the fact that there seems to be no general agreement as to whether interest rates will go up or down.

Here are a few thoughts about maximizing your income in investments:

1. As a general rule, banks pay lousy interest rates on savings accounts, frequently less than 1% per year. Don’t have any savings accounts.
   
   
2. Money market accounts and money market mutual funds are capable of paying a much better rate, but not all do. Check very carefully. Right now, the NEA-Sponsored/Bank of America Money Market Account and the Vanguard Prime Money Market Mutual Fund are both paying over 5%. Use this type of account for your cash type accounts.
   
   
3. Regular checking accounts are convenient and necessary.Typically they pay very little if any interest. Keep only minimal amounts in these accounts.
   
   
4. Short-term CDs are paying better than long-term. Stick with shortterm until the interest curve gets a little more normal.
   
   
5. Bonds and bond mutual funds will go down in value if interest rates go up.The longer the term left in the bond (or average maturity if held in funds), the more it will go down if rates go up.The key word here is duration (this is not the same as maturity). Duration is a measure of how much a bond or bond fund will go down if interest rates go up 1%.Any bond fund can easily tell you what its average duration is. For example, if a bond fund has holdings with an average duration of seven years, that means that if interest rates go up 1%, this bond fund will drop in value about 7%.The message here is don’t invest in long-term bond funds if you think interest rates will go up in the future.
   
   
6. Dividends are an attractive source of investment income. Many dividends qualify for lower income tax rates, 10% or 15% maximum. And, many companies pay higher dividends each year, which of course means the price of the stock will tend to go up since the income is going up.You can now purchase Exchange Traded Funds (ETFs) which invest in a basket of top dividend paying companies.You have no research or trading to worry about, and total management fees are maybe 0.6% or less. Just a couple of examples are symbol DVY and PEY. This type of investment, available through any brokerage account, is a good place for some of your money.
   
   
7. Real Estate Investment Trust (REITs) stocks, or funds that hold such stocks, have done very well over the past several years.They used to pay quite high dividends, but the price has gone up a lot so that now the effective yield is much lower. Still, a good REIT mutual fund is something you can consider for a long-term investment.
   
   
8. Limited Partnerships often pay quite high dividends. Some are higher risk than others. But I am reading that ETFs are about to become easily available that will invest in limited partnerships on your behalf, do the research, etc., and charge you a low fee such as 0.6%. You do have to be aware that limited partnerships may result in a more complicated income tax filing.
   
   
9. If you want to do a little research on income/oil fields, etc., I recommend you take a look at the Web site www.mcdep.com.The author looks at various oil and natural gas issues, some of which are paying in excess of 8% and are available on the major stock exchanges.Typically these are Royalty Trusts, but major oil companies like Exxon Mobil are also covered.
   
   
10. Requiring more work/research on your part, good quality preferred stocks are paying in the area of 6% and can be purchased through any brokerage account. For example, Bank of America has several preferred issues. One example is their “V” preferred which pays 6% of $25 each year (1.5% quarterly), and sells today for $24.63, a yield of not quite 6.1%. It is callable any time after 11/03/2009 (you would get $25 + any interest due), and matures in 2034. It is rated A.With preferred stock, you need to make sure how it is rated (I’d stick with A or better), when it matures, when it can be called and what the yield to call is. Don’t be tempted with just a high yield. I have invested in many of the above types of income issues, but have to admit that with the present interest rate situation it is much harder to find really good situations. So keep your investable cash in 5% money market type accounts and spend some time looking and waiting.

Posted March 26, 2007