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3 Dangers to Income Investors

Aug 07, 2012
Ron DeLegge

The Crane Money Fund 100 Index has a paltry 7-day yield of just 0.06% and investors are stretching for yield income. Here's what gets them in trouble.

Bernanke & Co. has set income investors up for disaster. If investors are not being plundered by depressed interest rates, then they’re being tricked into buying higher yielding but higher risk assets. Either way, the unwelcome results are about the same.

Let’s analyze three immediate dangers facing income investors.

Buying based upon historical yields
I had a listener to my weekly radio show ask me about the PIMCO Commodity Real Return Strategy Fund (Nasdaq: PCRDX) as an income play. The $20 billion fund sports a gluttonous 12-month yield of 19.17% and has yield junkie written all over it.

Most junkies pile into a fund like PCRDX without any second thoughts. Why is PCRDX’s 12-month yield so high? Because that figure includes 2011’s bloated year-end distributions. In contrast, the fund’s 30-day SEC yield is 2.66%. The latter figure is a closer approximation of the yield income today’s buyers are likely to get.

What’s the lesson? You should not make future investment decisions based upon the historical yield of a security, a fund or an ETF.

Going Long the Yield Curve
It’s understandable that a yield starved investor would want to squeeze a few extra basis points of income. And switching from shorter dated fixed income investments to longer term is what many have been doing. Why? 

Long-Term U.S. Treasuries with 20+ Year maturities (NYSEArca: TLT) carry a yield of 2.40% versus just 0.13% for 1-3 Year U.S. Treasuries (NYSEArca: SHY). Here’s the problem: When rates rise, and they inevitably will, longer-term Treasuries will suffer much larger losses compared to shorter dated debt. For that reason, going into longer-tem fixed income investments is a bad income trade. (On the other hand, it’s been a great capital gain trade, because falling rates have meant higher bond prices.)

Here’s the message: There are much safer ways to garner more yield than by piling into long-term Treasury bonds.

Thinking TIPS are safe
“TIPS” is the acronym for “Treasury Inflation Protected Securities.” In addition to U.S. TIPS (NYSEArca: TIP), investors can now choose among global (NYSEArca: GTIP) and international TIPS (NYSEArca: ITIP). The latter choices allow you to diversify your credit risk. 

Although TIPS were designed as a hedge against future inflation, (and it’s debatable whether they as perfect as TIP cheerleaders proclaim), they are not – I repeat – they are not a hedge against rising interest rates. Like other fixed income assets, the value of TIPS can and will decline as interest rates increase.

The tradition income strategy of investing in dividend paying stocks (NYSEArca: DVY) and bonds is good – but in today’s manipulated rate environment, other tactics are needed.

Safer yields can be achieved by using right combination of ETFs, options, and dividend income.

ETFguide’s Income Mix Portfolio has generated just over $7,000 in monthly income year-to-date, including dividends. The expense ratio average for this all-ETF portfolio is a rock bottom 0.18%, which is five times less compared to a comparable mutual fund portfolio.

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