More investors are searching for income and taking desperate measures. The Federal Reserve has pledged to keep interest rates deflated until 2014, which means the problem of generating adequate income will persist. Why arent traditional income sources delivering?
'Certificates of Depression'
Bank certificates of deposit (CDs) are a type of deposit account with a bank or thrift institution that typically offers a higher rate of interest than a regular savings account. CDs carry federal deposit insurance up to $250,000 and the interest rate is generally fixed for a certain period. Despite these assurances, todays CD yields arent high enough to earn investors any substantial cash flow.
Locking away your money in a 5-year CD at todays average annual yield of around 1.41 percent is a sure way to lose the buying power if interest rates creep higher. Furthermore, it would take you approximately 49.5 long years to double your money at 5-year CD rates!
Putting your money in a CD is the easy part, but taking it out can be another story. Many people fail to remember the maturity dates for their CDs and are later shocked to learn that they have tied up their money for five, ten, or even twenty years. Some CDs will automatically renew at maturity if you do not withdraw your money. A lack of liquidity is another overlooked problem with CDs.
Higher Risk, Higher Yields
Investing in bonds is another traditional income source. But many bond investors have strayed far away from their goal of safe income by increasing their risk.
Some bond investors are piling into exotic debt like bonds from emerging market countries (PCY - News). Although many of these countries have fast growing economies, they have less experience at managing financial shocks compared to developed nations.
In an article titled, Buyers take a Shine to Junk from the Wall Street Journal it showed how certain bond investors are piling into lower quality debt to squeeze more yield or income from their investments. Junk bonds (HYG - News) are high risk debt issued by corporations with a spotty credit score. Its almost like lending money to your cousin Vinny who never pays on time, except when Vinny misses a payment, you can put a brick through his window because you know where he lives.
Other investors have increased their risk by extending the duration of the bonds they own. For example, short-term Treasury bond ETFs like the iShares Barclays 1-3 Yr Treasury ETF (SHY - News) and the iShares Barclays Short Treasury Bond ETF (SHY - News) have a 12-month yield of just 0.77% and 0.07% respectively. These depressed yields have induced more than a few people to pile into long-term U.S. Treasury bonds (TLT - News), which carry yields in the vicinity of 3.40%. What they dont know is that long-term bonds are more susceptible to price declines when interest rates increase along with inflation.
Top Yielding Sectors
Investing in high paying dividend sectors is another way to grab more income. Historically, investors have flocked to industry sectors like utility stocks (XLU - News), real estate investment trusts (ICF - News), and master limited partnerships (AMLP - News).
This particular strategy has caveats. No matter how juicy dividends from individual stocks or sectors may appear, dividends are never guaranteed to remain the same and other hidden problems can suddenly arrive.
I distinctly remember, for example, how investors were piling into high yielding mortgage REITs (REM - News) from 2004-07, because annual yields in some instances had topped 16%. In 2008, mortgage REITs as a group collapsed 42% in value and shareholders in certain individual mortgage REITs were completely wiped out because their companies went bust.
Conclusion
Bernanke & Company are the primary culprits behind depressed interest rates that have demolished so many savers. As a result, traditional income sources that people have come to rely on arent delivering.
The ETF Profit Strategy Newsletter outlines another simple but proven income strategy. Our March income trade generated over $1,300 in monthly income. Instead of chasing high yielding ETFs, we use a time-tested strategy that institutional investors have been quietly using for decades.
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