LOS ALTOS, Calif. (
) -- What should you do if you need more retirement income from your portfolio?
People often ask about income investing. My contrarian opinion is that sometimes it is better to meekly accept a low yield from a low-risk, high-quality bond mutual fund than chase after high-yielding junk bond types of investments. If someone needs more cash flow than a low-yield allows, they will simply have to sell off and spend down a sliver of principal each year until the economy returns to normal and rates go up and default risk -- hopefully -- goes down.
You may feel you need more income in retirement, but there traps to be avoided in pursuing it.
Senior citizens' first priority is to avoid excessive risk, so that means avoiding things similar to junk bonds. Buying high-yielding stocks is risky because a stock could be going through the "value trap" and its price could drop drastically, with a permanent loss of principal. The only reasonable choices are bond funds paying no more than 5%, but they need to be diversified with more conservative funds paying 2.9%.
Life is unfair. Retirees are having their savings drafted into Bernanke's army and paid less than the "minimum wage" (just as people can be drafted out of a good-paying civilian job and be paid a nominal salary as soldiers in an Army) -- my analogy about the Fed's actions to push rates down to absurdly low levels.
A bond expert said in a speech that junk bonds actually produce a total return that is lower than "A" paper bonds because of losses to principal from defaults.
I am shocked at the opinion offered by many advisers that since some stocks yield over 3%, "Why not buy stocks instead of bonds because they yield more than bonds?" The problem is that stocks are overpriced and could easily drop 30% or even 50%; bonds, though they have inflation and currency devaluation risk, are far less risky.
Remember: Avoid interesting but risky investments.
Some mortgage REITs yielding in the mid-teens are interesting but to be avoided. They borrow at the Fed funds rate of under 1%, invest in mortgages yielding 3% and lever up the 2% profit by a factor of eight to produce that mid-teen yield. But this is extremely risky, because if interest rates rise they will have no profit, and the mortgages they own will drop in value -- resulting in losses that will probably be permanent. This would trigger mass panic selling of the stock, and the shares would drop significantly in value.
Avoid closed-end funds that increase payouts by paying a dividend that includes some of the amortization of principal coming from a maturing loan portfolio. This type of dividend yield is really part of the shareholder's principal, which is not the same as earnings. It is misleading and causes investors to accidently, unknowingly spend down part of their principal. If they want to spend down principal it should be part of a clear, explicit plan.
Another misunderstanding that creates the appearance of reliable, recurring income is when a bond mutual fund makes clever trades by buying distressed, defaulted loans at fire sale prices and sells them off at a profit after the loans improve.
Unfortunately, while this is a commendable act by the fund companies, it is a one-trick pony; eventually all the loans that can be salvaged and sold at reasonable prices will have been sold, and this source of extra income will end in a few years. Because the income stream has lasted for more than a year and it is income and not cash flow from amortization of principal, this is theoretically income a retiree could spend. It is not sustainable income, though, but a temporary surge in income due to the cleanup of the mortgage mess. Further, those operations incur risk that foreclosures could get worse, causing unexpected losses to those mutual funds.
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