Searching for Income
by Gerald Townsend, Financial Editor

Income-oriented investors should be much happier these days. After all, after numerous rate increases by the Federal Reserve, rates on money market funds and bank CDs are over 4%, which is quite an improvement from the paltry 1% level at which they were hovering a couple of years ago. Still, the rising rate environment has not been all good news, with bond mutual funds going nowhere since their values dropped as bond yields rose.

Other than money market funds and CDs what else is available for investors searching for income?

Tax-Exempt Bonds
Yields of 4% to 5% can be obtained from tax-exempt bonds, depending on the maturity and quality of the bond. While this doesn’t seem much different than what a CD might offer, consider this: For an investor whose combined federal/state tax bracket is 30%, a 4% yield would be the equivalent of 5.7% before tax and 5% equates to 7.1% before tax. Keep in mind that tax-exempt bonds issued by other states are free from federal tax, but not from North Carolina tax. Given that North Carolina’s individual income tax rate can be as high as 8.25%, tax-exempt investors can benefit from buying N.C. tax-exempt bonds, which are free of both federal and state taxes.

Floating-Rate Funds
Adjustable or floating-rate funds own bonds whose rates are tied to an index or are short-term and can adjust quickly to rising interest rates. Bank loan funds are an example of floating-rate funds. They invest in a pool of bank loans. The loans are normally made by banks for corporate financing needs, such as receivables or inventory financing, or for equipment acquisition. The loans are short-term in duration and usually tied to an index.

High-Yield Bonds
Investing in high-yield or “junk” bonds obviously entails some risk, but default rates on these bonds are low and shouldn’t rise in the current economic environment. Most people should limit themselves to high-yield mutual funds, and not buy the individual bonds. Yields of 8%+ are available.

Preferred Stocks
Yields on investment-grade preferred stock range from 7% to over 10%. Most preferred stock is either of long-maturity or has no maturity, which means it is especially sensitive to long-term interest rate increases. However, in the current market environment of relatively benign long-term rates, preferred stocks offer a good premium in yield over many other alternatives.

Common Stocks
While preferred stocks offer the highest yields, many common stocks provide some generous dividends while also having more growth potential than a preferred. Examples would be utility stocks and real estate investment trusts, where dividend yields of 4% to 6% can be found.

Canadian Oil & Gas Trusts
Not a familiar category to many investors, but these royalty trusts have yields ranging from 8% to 12%+. With the price hikes in the energy industry, these trusts have also enjoyed price increases, so investors may want to wait for a better entry point.

Investing for income is always challenging and investors should never focus just on the yield itself, as that leads to jeopardizing their principal. Allocating income investments among a variety of different types is usually the best approach.

Gerald A. Townsend, CPA/PFS,CFP®,CFA® is President of Townsend Asset Management Corp, a registered investment advisory firm in Raleigh, NC. His email address is Gerald@AssetMgr.com.