Many investors looking to generate income from their portfolios may have found the past few years rather frustrating. Now that the federal funds rate has started nudging upward—and bond yields have recently jumped from their record lows in 2016—is the landscape different for portfolio income seekers?
“Yields are higher, but still low by historical standards,” notes Rob Williams, managing director of income planning at the Schwab Center for Financial Research. And as yields do move up in earnest (Federal Reserve Chair Janet Yellen recently suggested that interest rates could rise three times in 2017), it could hurt the value of your existing bonds and other fixed income investments.
So where should you invest for income now? “You don’t want to chase yield if you are not also aware that higher yield adds risks,” warns Rob. And these days, he says, there really is no single solution that can give you everything you need. “If you set out looking for a “safe” 6% yield, unfortunately, today there are no investments that offer it.”
Still, there are many ways to invest for income, taking into consideration risk, reliability, taxes, interest rates and inflation. Depending on your situation, dividends on foreign stocks and interest payments from municipal bonds could be part of the answer. But rethinking your approach to generating income could be even more helpful.
Here are three strategies for boosting income from your portfolio.
1. Global dividends
With much of the world’s stock dividends originating outside the United States, it’s worth looking into foreign companies. While there may be additional fees associated with foreign securities (e.g., custody fees or currency conversion charges), foreign companies often pay out a higher percentage of their profits to shareholders than their domestic counterparts do. The dividend yield of the S&P 500® Index has been hovering around 2%—among the world’s lowest payouts, Rob notes. On the other hand, the yields of major European and Australian large-cap indexes, for example, have recently ranged from 3.5% to 4.5%.1 And whether you invest in individual stocks, mutual funds or exchange-traded funds (ETFs), venturing beyond U.S. shores in your search for dividend income has the added potential benefit of increasing the diversification of your portfolio.
Of course, investing overseas brings its own risks, ranging from political and economic uncertainties to swings in currency values that can decrease the value of the income you receive. Also, while most U.S. companies pay dividends every three months, international companies commonly make the payouts only once or twice annually. (In both cases, payouts are based on an annualized rate.)
2. Municipal bonds
The municipal bonds that state, county, and local governments and agencies issue to fund public works generally rank among the most stable of all investments. And while the fiscal health of some cities and states has been in question in recent years——Moody’s Investors Service reports that no Aaa-, Aa- or A-rated municipal issuer has defaulted in more than 40 years, and only 0.01% of munis with Baa ratings have failed to make promised payments to bondholders.
One of the biggest reasons to consider municipal bonds in taxable accounts is their potential tax advantages: The interest income you receive is normally free from federal (and sometimes from state and local) income taxes. Muni payouts are also exempt from the 3.8% Medicare surtax on net investment income—enacted in 2013—that may affect some high-income investors. Most other forms of investment income, in contrast, are impacted by the surtax, increasing munis’ potential tax benefits relative to other investments. In a low yield environment, every penny you keep, after taxes, helps.
Income from munis is also exempt from the 3.8% Medicare surtax.
You can purchase municipal bonds individually or through a bond fund. Because of their tax edge, most munis offer lower yields than comparable Treasuries or top-rated corporate bonds. But municipals may still give you more after-tax income. For example, if you’re in the highest federal income tax bracket for 2016 and are subject to the Medicare surtax, a muni with a yield of 2.5% is equivalent to a taxable bond yielding 4.4%.
3. Strategic selling of your portfolio
While both global dividend stocks and municipal bonds could help you make the best of a bad-yield situation, it may be even more useful to expand your whole idea of “income” by tapping your entire portfolio. In other words, don’t get trapped by the notion that bond interest coupons and dividend checks are your only options.
Instead, consider the total return on your investments, and look not only to periodic payouts from stocks and bonds but also to strategic sales of your holdings—with an emphasis on a strategic focus on when certain investments appreciate in value. “You can diversify your sources of return—interest, dividends, capital gains and principal—and use all of those sources to generate cash flow,” Rob says.
To take this approach, Rob says, you need a disciplined asset-allocation plan in which you can use relatively safe interest-earning investments (such as cash investments and short-term bonds) to serve two purposes: They can provide part of your income and create a foundation that lets you take more risk in other parts of your portfolio, to add investments not just with higher yields, but growth potential as well.
What’s more, adding proceeds from investment sales to your income mix could pay off whether you turn a profit or take a loss. If you sell at a profit, the federal capital gains tax bite on investments you hold for more than a year tops out at 20%—much less than the top personal tax rate of 39.6% that could apply to income you earn from interest on taxable bonds. “Capital gains are a form of return that can be tapped also, not just interest payments,” Rob says. And if you harvest losses to offset the gains, you can reduce the tax bite as well.
Overall, you’re likely to find more income when you look beyond the usual suspects and strategies, consider the specific opportunities that today’s market offers and look at how your current holdings can generate more income, too.
1. Dividend yield data as of 3/1/2017. EURO STOXX 50 Index: 3.56%; FTSE 100 Index: 4.18%; S&P/ASX 200: 4.43%.