It’s no secret that traditional fixed income investments (money market funds, U.S. treasury bills, and certificates of deposit) pay returns that are something close to nothing. Worse, this situation has continued for several years. An allocation in fixed income assets has become an unproductive investment, especially when inflation is calculated into the mix. But there are fixed income options that will allow you to earn a better return on your investments.
As we take a look at those investments, you may be surprised to learn that there are more available than is commonly assumed.
A word of caution before we begin – A major part of the reason that traditional fixed income investments pay so little is because they are virtually the safest securities on the planet.
In order to increase your return on investment, you will have to take on a greater amount of risk. That is the case with each of the investments listed below. You’ll have to decide for yourself which is more important, a higher rate of return on your money, or absolute safety of principal.
In addition, I’ve provided some examples of investments in each asset category as evidence of what’s available. But please understand that in each case, these are examples and not recommendations.
Should you choose to invest in any of these asset categories, it’s absolutely essential for you to perform due diligence investigation of both the specific investment and the current investment environment affecting it.
Peer-to-Peer (P2P) Lending Platforms
These are online web platforms where borrowers and investors come together to create mutually agreeable loan arrangements. Both are attempting to bypass traditional banks, enabling the borrower to pay a lower rate on his loan, in the investor to earn a higher return on her investment.
With $5,000 you can diversify across 200 notes. That’s something that you will want to do, because there is a risk of default on any one loan.
Treasury Inflation Protected Securities (TIPS)
These are U.S. government bonds and notes that pay interest, and will guarantee the full return of your principal as long as the securities are held to maturity. And not only do they pay regular interest, but they also make annual additions to your principal based on changes in the Consumer Price Index (CPI). This ensures you’ll earn the stated rate of return, over and above the effects of inflation.
TIPS are available in terms of 5, 10 and 30 years, and in denominations of $100. It’s a way of making sure that at least some of your fixed income portfolio allocation will be protected from inflation.
Real Estate Investment Trusts (REITs)
REITs are something like mutual funds that invest in real estate. They can do this either through equity positions in actual properties, or through mortgages held on those properties. They tend to offer yields that are higher than what you will get on traditional fixed income investments, and they are generally completely liquid.
For example, One Liberty Properties, Inc. (OLP) is currently yielding 6.90%, while W P Carey Inc. (WPC) is at 6.20%. Both are paying yields that are well above even the rate on 30 year U.S. Treasury bonds.
High Yield Dividend Stocks
There are stocks that pay dividends that are higher than the general market, and certainly higher than traditional fixed income investments. They tend to be large, well-established well-capitalized companies, with a long history of paying out dividends, and often increasing those dividends on a regular basis.
In addition to high dividends, they also offer the prospect of capital appreciation if they are held for many years.
Preferred stocks represent equities that have a higher claim on both the earnings and assets of a corporation than common stock. They typically pay dividends, and those dividends are a priority over those that are paid out on common stocks.
As the preferred stockholder, you generally have no voting rights in the company, however you will have a steady stream of income.
Emerging Market Bonds
These are debt securities that are issued by both governments and corporations in emerging market countries. They generally offer much higher interest rates than what you can get in the U.S., precisely because their market is less secure.
For that reason, you should necessarily want to limit the exposure that you will have with this type of investment, to a small part of your fixed income allocation.
You’re probably best to go with a fund for this category, since investing in emerging markets involves a high degree of specialization. A fund like GMO Emerging Country Debt Fund (GMCDX) for example is currently yielding 7.59%.
If All Else Fails, Pay Off Debt
If you are not comfortable with the additional risks involved in any of the above asset classes, you can always opt to pay off debt. It offers a locked in “rate of return” on your money, that is absolutely guaranteed no matter what.
Let’s say you decide you don’t want to invest in any of the suggestions above. You have $50,000 earning less than 1% per year at your local bank, and you’d like to get a better return on your money. But you have $25,000 in debt of all kinds — a car loan, credit cards, and a home equity line of credit. The average interest charge on all of these loans is 7% per year.
By paying off all of these loans, you will effectively lock-in a 7% annual rate of return. When you blend that with the other $25,000 that is still in the bank earning 1%, your average return across the board will increase to 4% per year.
That’s not a bad deal at all, especially for a zero risk investment.
If you do decide to take advantage of some of the fixed income investment alternatives above, be sure to factor risk into your portfolio.
The best strategy may be one in which you maintain a healthy amount of money in traditional, low yield investments, while adding enough of the alternatives that you will increase the overall return on your fixed income allocation to something substantially higher than what it is now.
It’s a delicate balancing act, but now that it looks like low interest rates are here to say, it’s time to create just such an alternative strategy.