Earlier this week, I explained some of the basics of fixed income investments. You can refresh yourself here if you need. But I’ll also give you a brief recap.
These are probably the most boring investments in the world. And they’re often ignored for the more glamorous world of equities. But when it comes to protecting your money and providing a steady stream of income, there’s nothing better.
Even if you’re far from retirement, you can benefit from having a safer place to park and grow money you don’t plan to use immediately.
Investing in fixed income securities helps to diversify away risk from your portfolio, smoothes out volatility from your returns, and provides you with a regular, predictable stream of cash. You can use that to pay your expenses or reinvest it to make your profits grow even more.
So now that you’ve got a better idea of why fixed income investing is a good idea for everyone, let’s get into some of the best investments and talk about how you can protect your money while still letting it work for you.
A Security for Every Investor
Now, to buy bonds, you usually have to get into pretty big lots — I’m talking a thousand at a time. And with par values at $100, that’s some serious change to be throwing around.
If you’re like me, you just don’t have that much to put into individual investments. If you do, that’s great, but this solution will work for you, too. Thanks to the days of electronic trading and easy access to everything via the Internet, there’s a simple way for retail investors to get in on the bond action: ETFs.
But these aren’t your typical ones that invest in a basket of stocks. No, no. These funds keep a rotating stable of corporate and government debt and share the rewards with shareholders.
Treasury Bills — Like the U.S. dollar, Treasury bills are backed by the full faith and trust of the United States government. Despite occasional last-minute arguing between political parties, the U.S. is like the Lannisters (Game of Thrones fans will understand) — it always pays its debts. This makes these securities practically risk-free. I say “practically” because there’s still the risk that inflation will mean your dollars aren’t able to buy as much when you get them back as they were when you put them in. But you can rest assured you’ll get them back, and you’ll also get your interest paid when it’s due.
The best short-term Treasury bang for your buck is going to come from the iShares 1-3 Year Treasury Bond Fund (NYSE: SHY). As the name would suggest, it invests in T-bills with maturities between one and three years. The majority of these come due around the same time, so there’s no worry that high interest rates will cut into your principle.
Municipal Bonds — Like U.S. Treasuries, muni bonds are backed by the government — in this case, a state. They’re usually issued to generate some cash to make improvements to roads, bridges, and other state-maintained assets and can reward investors with pretty nice interest payments. They’re not quite as risk-free as Treasuries, but they still offer a lot of default protection.
Again, short-term muni bonds are the way to go, and the best bet for the retail investor comes in the form of the iShares Short-Term National Muni Bond ETF (NYSE: SUB). It invests in a smattering of bonds from solid state governments across the United States and pays investors a 0.76% yield coupled with three-year average returns around 1%. Not a high-flying stock investment, but also not nearly as risky as equities.
Corporate Bonds — Issued by companies in an effort to drum up cash for internal investment, these bonds are a little riskier than those of state and national governments, but they still offer protection against default. Holders of these are entitled to some of the firm’s assets in the case of a bankruptcy. They also pay higher yields to compensate for the somewhat increased risk.
When it comes to ETFs for corporate bonds, you can’t get much better than the Vanguard Short-Term Corporate ETF (NASDAQ: VCSH). It holds debt from some of the best and most solid companies in the U.S., so your risk of default is very low. And an investment in this fund scores you a 2.03% yield along with a three-year average return of 2.62%.
Preferred Stock — These are much easier for retail investors to get into without the use of an ETF. They’re issued by companies in lieu of common stock in an attempt to raise money without diluting common shareholders’ equity. They pay a steady dividend based on the par value of the stock and give the holders more rights in the event of a default.
Since they trade just like a stock, there’s no reason to only stick with the short-term ones — you can sell them on the market if you ever need the funds. And the absolute best that I know of happens to also be an investment that’s already returned double-digits for my subscribers at The Wealth Advisory. Alcoa Class B Preferred Shares (NYSE: AA-PB) are the way to go if you’re looking to get into a preferred stock investment. They pay a current yield of around 7.5% and are paid in arrears if the company isn’t able to make the quarterly payment on the predetermined date. That hasn’t happened yet, and I don’t expect it to happen soon, but it’s a nice insurance to have anyway.
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It contains full details on why dividends are an amazing tool for growing your wealth.
Certificate of Deposit — You’re already probably pretty familiar with these. You might even have one or two and didn’t even realize you were a fixed income investor. They’re savings accounts offered by banks where you loan them money for a specific amount of time, and they pay interest and promise to return the principle upon maturity. The longer you let them use your money, the higher an interest rate you’ll typically get. And best of all, they’re insured up to $250,000 by the FDIC so you’re safe in the event of a failing bank.
For a great rate and a bank that’s not in danger of going under (and is FDIC-insured anyway), you can’t go wrong opening up a five-year certificate of deposit with GS Bank (a new consumer bank started by Goldman Sachs). Your money will be tied up for five years, but you’ll be paid 1.83% interest and refunded everything up to $250,000 in the rare event that Goldman goes under.
Don’t Forget to Diversify
Just because I’m telling you about the benefits of fixed income investments doesn’t mean I’m telling you they’re the only thing you should invest in. They help reduce risk and mitigate volatility, but the best way to get your risk as low as possible and also secure top-notch returns is to diversify your portfolio.
So make sure you’ve got fixed income investments, yes. But don’t replace all of your equities with them. And always keep cash on hand in case you have an emergency or see an opportunity to buy more securities — both fixed income and equity.
To investing with integrity (and all the right tools),
Jason Williams
Wealth Daily
Follow me on Twitter @AllBeingsEqual
