If you are near retirement, you’ll want to read what I have to say here, as it could mean the difference between retiring comfortably and struggling to get by. The reality is that in this low interest rate environment, those seeking income are squeezing out very little income flow.
The point is that unless you have millions in liquid cash, the thought of earning a two-percent yield on a 10-year bond probably makes you nauseous.
There is no secret to making your dollars work to generate income and gains. To make higher expected returns, you need to expand the risk you are willing to take.
Some pundits argue for buying high-yield bonds to jack up your total returns. This makes sense to some degree, but you also need to be aware that you are assuming more risk—especially default risk—if the domestic and global economies continue to struggle.
You know that high-yielding bonds are usually associated with companies characterized by weak, debt-laden balance sheets.
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The threat of default in these cases is usually above-average, while the rating is below investment-grade and could be as low as junk. The potential yields are high, but so is the default risk.
Take a look at some of the energy or copper plays. Here you have companies facing plummeting commodity prices, while dealing with declining cash flow and mounting losses. Companies in this situation looking to raise capital to finance expenditures will have to pay much higher yields to attract investors.
If you want to add some risk to achieve higher returns, I suggest making sure you are well diversified as far as the bond quality of your portfolio. Make sure you carefully select high-yielders where the company is showing some positive signs of a coming turnaround.
Another option to increase your total expected income flow is to add large-cap dividend stocks.
For income investors, I currently believe the big banks offer a decent risk-to-reward investment, as many have been sold off despite reporting decent quarterly results.
I would avoid those banks with heavier-than-average exposure to the energy and commodity sectors, though.
You may want to take a closer look at stocks like Wells Fargo & Co (NYSE:WFC), JPMorgan Chase & Co. (NYSE:JPM), and Goldman Sachs Group Inc (NYSE:GS), to name a couple. These stocks have been battered, but they offer a great dividend income stream for investors preparing for retirement.
If you want a diversified play on the financial services sector, take a look at an exchange-traded fund (ETF), like Select Sector Financial Slct Str SPDR Fd (NYSEArca:XLF) or iShares Dow Jones US Reg Banks Ind. (ETF) (NYSEArca:IAT) for smaller banks. Banks are a great way to receive dividends and capital gains when the sector reverses.
And if you are willing to assume risk and think long-term, an ETF like SPDR Index Shares Fund (NYSEArca:GNR) may fit with your plans and could be worth a closer look. This ETF has a current yield of 4.9% and offers a strong capital gains opportunity off a commodities rally.
The fund tracks the S&P Global Natural Resources Index and comprises a diversified group of about 90 U.S. and global companies. The fund is 57% invested in basic material and 32.5% in energy. The performance numbers are horrible, but it can be beneficial to add the ETF at a big discount from its high.