3 Ways to Help Increase Portfolio Income | Charles Schwab

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3 Ways to Help Increase Portfolio Income

March 14, 2017

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.

The potential for higher yields comes with greater credit risk.

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%.

Important Disclosures

Past performance is no guarantee of future results.

Some specialized exchange-traded funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and cannot protect against losses in any given market situation.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.

The Bloomberg Barclays EM Local Currency Government Index is comprised of local currency treasury debt from 22 countries with a sovereign rating of A1/A+ or World Bank income classification of Low, Low/Middle, or Upper/Middle.

The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.

The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

The Bloomberg Barclays Municipal Bond Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and prerefunded bonds.

The Bloomberg Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index is a market value-weighted index that tracks inflation-protected securities issued by the U.S. Treasury. To prevent the erosion of purchasing power, TIPS are indexed to the non-seasonally adjusted Consumer Price Index for All Urban Consumers, or the CPI-U (CPI).

The Bloomberg Barclays U.S. Government Bond Index comprises the U.S. Treasury and U.S Agency Indices. The index includes U.S. dollar-denominated, fixed rate, nominal U.S. Treasuries and U.S. agency debentures (securities issued by U.S. government owned or government sponsored entities, and debt explicitly guaranteed by the U.S. government).

The Bloomberg Barclays Global Aggregate Bond Index is a flagship measure of global investment grade debt from 24 local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.

The EURO STOXX 50 Index, Europe’s leading blue-chip index for the eurozone, provides a blue-chip representation of supersector leaders in the eurozone. The index covers 50 stocks from 12 eurozone countries.

The FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange.

The S&P/ASX 200 is recognized as the institutional investable benchmark in Australia. The index covers approximately 80% of Australian equity market capitalization. Index constituents are drawn from eligible companies listed on the Australian Securities Exchange.

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