Strategies help risk-shy investors stretch for yield as rates stay low

Earlier this year, it looked like higher interest rates were all but inevitable — a prospect that could have helped savers but hurt bond investors.

Now it appears rates could remain stuck at ultralow levels for even longer, meaning anyone hungry for yield will have to work harder to get it. Yields on U.S. Treasuries and other bonds have fallen in recent weeks, and the International Monetary Fund warned the Federal Reserve that it risked choking off the U.S. economic recovery if it raised rates too quickly. So, if low rates are going to be with us for a while longer, here are some strategies to ponder:

Avoid yield losers.

Certain types of saving and investment instruments just aren't paying enough to bother with if income is your goal. Money market mutual funds and short-term CDs are two primary examples. So are U.S. Savings Bonds. Inflation-adjusted Series-I bonds currently are paying nothing, and that will continue at least until Nov. 1, when rates reset again. Their Series-E siblings aren't doing much better, yielding 0.3%.

These instruments are fine if you mainly want to protect principal. And if rates start rising, they will start to pay higher yields fairly quickly, with no prospect for capital losses. But at current yield levels, they're best avoided.

"The problem is that the Federal Reserve has forced people to take risks or earn nothing," said David Daughtrey, a chartered financial analyst at Copperwynd Financial in Scottsdale, Ariz. CDs, money-market funds and U.S. Savings Bonds are among the ultraconservative instruments from which yields have been wrung out.

Accept some volatility.

Bonds pay higher yields than CDs. But there's a danger to them: When rates rise, bond prices fall, and bonds with long-term maturities are most vulnerable.

Historically, investors in long-term corporate bonds have lost money about one year in five on average after including the bonds' interest income, according to Morningstar and Ibbotson Associates. Considering that rates have been in a general downtrend for 35 years, the next prolonged move almost certainly will be up — and it could pack a wallop, saddling investors with sizable losses.

But it hasn't happened yet. Given the sluggish global economy and the Greek debt situation, rate hikes could be muted, if they come at all. Bonds do stumble in price on occasion, but any losses usually are modest. Annual losses of even 5% have been quite rare, coming only once every 18 years on average.

Bond investors often can pick up higher returns by venturing into high-yield corporates or foreign issues. Daughtrey also likes floating-rate funds such as PowerShares Senior Loan, T. Rowe Price Floating Rate and Guggenheim Floating Rate. These funds own variable-rate bank loans and bonds issued by second-tier corporations. The funds aren't risk free, but the floating-rate nature can help mitigate the risks from higher interest rates. The funds' recent yields have hovered near 4%.

Build a bond ladder.

A simple way to capitalize on rising rates, while mitigating the fallout from possible losses, is to build a bond ladder. This involves buying bonds with a range of maturities. That way, you will always have a bond coming due reasonably soon. If rates rise, proceeds from the next maturing bond can be reinvested at the new higher yields.

"It's a very simplistic approach but also very effective," said David Ashley, associate portfolio manager at Thornburg Investment Management. "It's easy to explain, and it performs."

Many bond funds utilize a laddering approach, holding a mix of issues with maturities spread from short to long term. Also, funds constantly have new money flowing in from investors that can be used to buy new bonds at higher rates, should they materialize. Investing in a fund that takes a laddering approach can be easier, and more affordable, than trying to put together a portfolio of dozens of individual issues on your own.

Laddering also can be used with CDs. The approach hasn't worked all that well lately because CD yields have been low, and pretty flat, across the board. Laddering would prove more profitable if rates shifted to a more normal pattern — where, say, five-year CDs paid considerably more than those coming due in a few months.

Step into the stock market.

If you're willing to cross the Rubicon, then the stock market is the next logical place to pick up yield. Many stocks are paying decent dividends — comparable to what you can find in the bond market, where a 10-year Treasury, for example, pays about 2.4%.

Among high-yielding categories, REITs, or real estate investment trusts, are hard to beat. These companies generate income from rents and mortgage interest, while avoiding federal income taxes by passing the bulk of their cash flow to shareholders as dividends. REIT yields currently average about 4.3%.

With all stocks, you must accept the risk of fluctuating prices and occasionally steep declines. The flip side is that stocks outperform bonds over time and companies often raise dividends, unlike the fixed payments on bonds. Researchers at Standard & Poor's have identified "dividend aristocrats" — big corporations that have increased their dividends for at least 25 straight years. They include AT&T, Leggett & Platt, McCormick and Stanley Black & Decker.

Reach Wiles at russ.wiles@arizonarepublic.com or 602-444-8616.