Passive Income Strategies Put Your Money To Work

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Rentiers, people who live off passive income, have a bad name in some socioeconomic circles, but a portion of that has got to be sour grapes. The rap against passive income is that it is an undeserved reward that can encourage unsavory actions like bribery to keep it coming. But it is pretty hard to see the harm in a worker’s savings account or low-risk bond income.

There are more exotic forms of passive income than that, and some of them hold appeal for investors who have yet to reach fat-cat levels. Here are three ideas for passive income generation in the current economic environment:

A special kind of short-term junk-bond fund
Stocks that increase their dividends every year
Annuities that make sense for retirees, especially those depending on U.S. Social Security past 2033

Passive Income Investment Ideas

#1. Take A 3-Year Dip Into Junk Bonds

U.S. junk bonds are having a moment. With yields around 8% this week while investment-grade corporates and money market funds are more than two percentage points below that, there is a case to be made for jumping into short-term high-yield bonds.

High-yield debt is usually high-risk debt, but the danger is mitigated by rising confidence that the U.S. is not facing a recession in the near-term combined with a Federal Reserve whose next move is more likely to be an interest-rate cut than an increase. So if you are willing to discount the chance of so-called black swan events, short-term junk bonds seem to be offering a win-win proposition: if the economy stays strong, the risk of defaults is limited; if it weakens, the Fed seems willing and able to loosen monetary policy, which could aid issuers of high-yield debt.

If you buy the story, then there are two sets of exchange-traded funds that are tailored to such a strategy, offering diversity and protection from interest-rate swings: iBonds from BlackRock and Invesco’s BulletShares. Each ETF in the series buys a portfolio of bonds that come due in a specific year, collect interest until maturity, and then return the principal to investors. They were created for bond laddering, which avoids the problem of trading losses in other kinds of funds by holding their securities until maturity. With a one- or two-rung ladder this is a really passive investment–not only do you buy it and let the income roll in, you do not even sell it; you just wait for the principal to come back to you when the bonds mature.

The iBonds fund maturing in 2025, known by its ticker IBHE, recently yielded 7.7% to maturity and IBHF for 2026 is at 8.1% The comparable BulletShares, BSJP and BSJO, respectively, both yield about 8%, according to data from Bloomberg.

Brian Armour, director of passive strategies at Morningstar Research, agrees, “the risks are pretty low for high-yield right now” but he notes that junk debt is never a sure thing. In fact, the premium offered by high-yield bonds versus Treasurys has fallen almost to pre-pandemic levels, a sign that risk has bottomed out and could rise from here. Still, investments that expire in less than three years in an economy where recession fears have abated limit concern about default, although it is possible you will not be able to obtain yields at this level in 2027 after they mature.

For now though, employment remains strong and the Fed increased its economic growth forecast for the year to 2.1% from 1.4%. The central bank remains poised to cut interest rates this year, though perhaps not as quickly as investors had expected, especially with inflation remaining above target. Against that backdrop, 8% for the next couple of years seems like a fair return.

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High-Yield Bond ETFs With Yields Above 7% And Limited Maturity Risk

Junk-debt ETFs from BlackRock and Invesco whose holdings will mature in 2025 and 2026.

BlackRock, Invesco, Bloomberg

#2. Ride Dividend Increasers For The Long Haul

Achievers. Aristocrats. Kings. These are among the names used to describe companies that raise their stock dividends every year. As long as they can keep it up, they provide an ever-increasing stream of passive income, often with less volatility than more pedestrian equities.

These stocks do not necessarily offer high yields relative to other dividend payers. But patient investors who pick companies that succeed in raising their payouts in good times and bad end up with income streams that can swamp the returns offered by the bond market.

There is a trade-off: The money a company sends to its shareholders could instead be reinvested in its business to spur sales and profit growth.

“Dividend-growth investing appeals to investors looking for rising income over time,” says Ben Reynolds, founder of a 10-year-old website called Sure Dividend that tracks stocks with payouts. “This is especially beneficial to investors in or near retirement who want to help offset the wealth-eroding effects of inflation on their income stream with actual income growth.”

American States Water (AWR), the U.S. company with the longest streak of annual dividend hikes at 69, illustrates the concept. The California-based utility currently yields 2.5% after a September increase in the quarterly dividend to 43 cents from 39.75 cents. That yield is about double what you could earn on the shares in the Standard & Poor’s 500 with only three-quarters the volatility, data from Bloomberg show, but over the past 10 years the stock’s total return of 10.2% trails the index’s 12.7%.

When compared with the 4.6% on 10-year Treasury bonds, however, American States shares shine. The company aims to increase its dividend by 7% a year and boasts that it has achieved 9.4% over the past five years. Sure, there’s more risk than with Treasurys, but the company has been paying shareholders since Herbert Hoover was president. There are more than 50 companies, known as Dividend Kings, that have paid dividends for over 50 years.

Longevity is not the only important criterion for finding dividend-increasing stars, says Reynolds. He says to look for long-term payers that have kept their streaks going through the Great Recession and the Covid-19 pandemic. Measured from the March 9, 2009, low on the S&P 500, that is just over 15 years.

These five shares are among Reynolds’ favorites from the companies he follows, based on factors that include the current yield and its expected growth rate and the percentage of earnings required to support the dividend: Genuine Parts (GPC), which is tied for second place among the Dividend Kings at 68 years of increases; home-improvement retailer Lowes (LOW), the “super-safe” McDonald’s (MCD); human resources management software and service provider Automatic Data Processing (ADP); and insurer UnitedHealth Group (UNH).

Take A Hike

Five stocks with long streaks of dividend increases that seem to have room to run.

Sure Dividend, Bloomberg

It pays to diversify among several stocks in this kind of strategy because even the best companies find themselves unable to maintain dividend increases. Take General Electric, once the most valuable company in the world, which this month completed a dismemberment that began after it abandoned a three-decade string of rising dividends in 2008.

Reynolds also says investors looking for long-term payout hikes should avoid industries subject to rapid change, which argues against technology businesses. “The companies with the longest streaks tend to be in the consumer staples sector and the industrial sector. There’s a lot of utilities too.”

For more diversity, investors can turn to several funds that follow dividend-increase strategies. The Proshares S&P 500 Dividend Aristocrats ETF (NOBL) is based on an index that requires 25 years of dividend increases and only includes companies in the Standard & Poor’s 500. It has returned an average 9.2% over the past five years and yields 2.1%. ProShares offers eight ETFs that focus on dividend growers, including three based on international companies.

At Invesco, the High-Yield Equity Dividend Achievers ETF (PEY) holds the 50 stocks with the top yields among the Nasdaq Dividend Achievers index, which contains U.S.-exchange-listed stocks with a decade of rising payouts along with three-month average trading volume of $1 million. Its top holdings include tobacco maker Altria Group; Leggett & Platt, a manufacturer of components for furniture, automotive seating and retail store fixtures; and Verizon Communications. Its yield is 5.2% and the fund has returned 5.7% a year in the past five years.

Another Invesco fund, Invesco Dividend Achievers ETF (PFM), tracks the entire Nasdaq U.S. Broad Dividend Achievers. It benefits from tech leaders Microsoft, Apple and Broadcom and is up 9.8% annually over the past five years while yielding just 1.8%.

While using funds to hold dividend increasers is “definitely a viable way to do it,” Reynolds says “If you like stocks, you like reading about it, buying individually is better. There are no fees, you know what you own.”

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#3. Rest Easy With Basic Annuities

There are two good reasons for Americans at or near retirement to be looking at annuities right now. One is the risk that the Social Security system may be forced to reduce benefits in 2034, the other is a relatively new method of temporarily reducing the required distributions people must take from their retirement accounts.

Annuities get bad press for being confusing, expense-ridden and low-yielding investments. But they are not really investments at all.

“When you buy an annuity,” says Bob Carlson who runs the RetirementWatch website and is a senior Forbes contributor, it is because “you do not want to take the risk that you are going to live a long time.” Many people, he adds, “do not “study life expectancy, so they don’t know the real risk.”

The contracts also provide protection against bad investment decisions or market declines after purchasers retire.

Looked at that way, it is the reliability rather than the rate of the return that is the charm, and Carlson says he is unaware of any defaults in modern history. There are however, $2.2 billion of annuities tied up in court cases involving insurers controlled by Greg Lindberg, according to the Wall Street Journal. Lindberg is accused of fraud, but the structure of the annuities themselves is not an issue.

In about a decade, U.S. Social Security will reduce promised benefits by about 20%, based on current projections, unless the government changes the way the program is run. Having a second source of fixed payments sounds like a pretty good idea to protect against the risk that Washington fails to honor its Social Security pledges.

The drawbacks: Carlson prefers annuities that will cover buyers for as long as they live, but if you die before payments start, then the entire premium is lost. There are ways around that, but they add to the costs. Also, there is no inflation protection as such, although many plans offer an option for automatic payout increases of 1% to 5%, which reduces the initial monthly level.

One option Carlson does like is setting the annuity up to cover a spouse so that the payments continue until both people have passed away.

Annuities can be purchased inside of retirement accounts or out, though in the latter case they may be subject to taxation. Because Carlson views them as insurance against better-than-average longevity, he does not recommend people use annuities as the sole source of retirement income.

One kind of plan that he likes is a deferred income annuity (DIA). With this option, you give the insurer a chunk of change and decide when you want to start getting paid. Then you just have to live long enough to start collecting.

Carlson says this kind of annuity is best for people who are near or in retirement and have sufficient savings to shift funds from other investments.

With this approach, a 66-year-old male New Yorker using $100,000 of IRA money and aiming to begin withdrawals in 2034—when Social Security might be reduced—would receive monthly payments of $1,437-$1,481, based on quotes from different insurers at the ImmediateAnnuities website. A 2% annual increase cuts the benefit to $1,296.

There is a lot more bang for the buck if he waits until 2043, when he turns 85: $4,291 to $4,745, without a cost-of-living adjustment, or $4,260 to $4,336 with 2% protection. You aren’t limited to just one of these, Carlson says, so you could buy two or more that mature in different years, adding new income streams as you age.

There’s a twist under a law that took effect in 2014 that makes these annuities even more attractive. Called qualified longevity annuity contracts (QLACs), they effectively reduce your required minimum distributions (RMDs) until the payouts start. There are a number of restrictions, including a cap of $200,000, and for accounting reasons QLACs essentially have to be placed in their own IRA accounts, not combined with other assets.

The RMDs are calculated and handled by the insurance company that provided the QLAC once they start, and you remain responsible for separately figuring and paying the reduced distributions on the rest of your retirement portfolio. Among the restrictions are that distributions from QLACs must start between the ages of 72 and 85.

A variation on the DIA is a single-premium immediate annuity, where you pay a lump sum and get a return that usually starts right away. With one of these, the 66-year-old New Yorker would get $583 to $657 a month or $484 to $545 with a 2% annual increase.

For people still working, Carlson suggests deferred fixed annuities, which are also called multi-year guaranteed annuities. He likens the structure to a “certificate of deposit in an annuity wrapper that is tax-free until you take it out.”

The yields can be a little more than those on CDs, “roughly equivalent to an intermediate-term bond,” he says, with principal guaranteed and often a minimum yield as well. In most states, an investor could earn 3.9% to 5.6% for 10 years, another ImmediateAnnuities calculator shows.

Annuity providers, Carlson says, are better able to shoulder the risk of your potentially longer-than-average lifespan than you are. A prudent person would have to prepare for a very long life, while an insurance policy only has to get the average longevity right. Those that die young effectively finance the lengthier retirements of the longer-lived members of their cohort.

Passive Income Strategies Put Your Money To Work–All You Have To Do Is Watch