The U.S. economy is sputtering, so the Federal Reserve is slashing interest rates. That may help borrowers and stimulate business activity, but those lower rates also mean skimpy investment yields.
Since last September, for instance, the average yield on money market funds has fallen from nearly 5% to around 2.5%. In this environment, what can you do to get a decent yield?
1 Shop around for high-yielding bank CDs. “As of now, the average yield on a 1-year CD is 1.97%,” says Greg McBride, senior financial analyst at Bankrate.com in North Palm Beach, Florida. “If you go online, you can get 4% or higher from some banks.”
If you think rates are going to stay low for a while, lock in yields of slightly more than 4% with a 5-year CD. One place to search for the highest yields is www.bankrate.com.
2 Stock up on dividend-paying stocks. Since reaching record levels in October, the major stock market indexes have tumbled. Many sound companies that continue to pay dividends have suffered steep price drops. This presents an opportunity for greater yields. For example, suppose a company trading at $50 a share was paying a $2 annual dividend-a yield of 4%. If the stock has fallen to $40 yet the dividend remains at $2, the annual yield is now 5%.
What’s more, stock dividends generally qualify for a bargain 15% tax rate, under current law. (CD interest is taxed up to 35%.) If your taxable income is less than $32,550 this year, or less than $65,100 on a joint return, you’ll owe no tax at all on qualified stock dividends. REIT payouts generally don’t qualify for bargain tax rates, but they may be higher than stock dividends.
If you’d rather not attempt to pick individual REITs or dividend-paying stocks, there are specialized funds available. WisdomTree Small Cap Dividend Fund (DES), for example, is an exchange-traded fund that pays 4.01%. If you’re wary of a small-company ETF, PowerShares High Yield Equity Dividend Achievers (PEY) is an ETF holding midsize and large companies with a history of increasing dividends, and it pays 5.4%. For REITs, consider Vanguard REIT ETF (VNQ), which offers an appealing 5.3%.
3 Avoid the IRS by buying municipal bonds and muni funds. High-bracket taxpayers might consider tax-exempt bonds, where yields now compare favorably with taxable issues. For example, Morningstar puts the average yield of taxable intermediate-term bond funds at 4.6%. If you are in a 28% federal tax bracket, you’d wind up with only 3.3%. You’d be better off in intermediate-term muni funds, where the average yield is 4.2%, after tax.
Some funds handily beat the average yield. USAA Tax-Exempt Intermediate-Term (USATX), for example, has a four-star rating from Morningstar and as of late March paid 4.6%, free from federal income tax.
You can also invest in individual bonds, boosting your yields while avoiding fund fees. “Your best strategy might be to build a bond ladder,” McBride says. “A similar strategy would work with bank CDs.”
This means that you might, for example, buy a municipal bond maturing in