Easy, No-Risk Ways To Boost Dividend Yields

Income investors have had a rough time. Even after the recent run-up in interest rates, yields still are far below what they were a few years ago. Income investors whose investments have matured have had to reinvest to receive lower income.

It is understandable that long time income investors don’t want to take the risk of seeking higher returns in the volatile stock market. But income investors need to reassess their strategies. There are some very simple, low-risk changes that can be made to increase net income. Changes in the markets will let you turn the tables on Wall Street in a big way.

The best way to increase income is to reduce costs. When your yield is 5%, a 1% expense ratio takes away 20% of your income. If you pay a front-end load to buy a bond fund or some other expense, your income is chopped even more. But you no longer are at the mercy of expensive middlemen for income investing. Take a look at these strategies.

Use the low-cost option. The Vanguard Group has the lowest bond fund expenses and charges no loads. That gives it a strong advantage over every other bond fund. The other funds have to invest dramatically better than Vanguard to earn a higher yield, and very few can. With interest rates in a long-term downtrend, bond fund managers will have fewer opportunities to use trading to make up for high expenses. Don’t pay a load for a bond fund, and shop for low expenses. You’ll probably end up with Vanguard.

Index your bonds. Stock market indexing gets a lot of attention, but bond index investing probably is one of the next great investment waves. In the past, actively-traded bond funds could beat the bond indexes easily. That is because interest rates were falling sharply. All a bond fund had to do was buy longer-term bonds than the index, and the fund would have a higher return. Big yield differences between different types of bonds (treasuries, corporates, etc.) also gave active bond managers an easy advantage over the indexes.

But those advantages are disappearing. Even if interest rates fall in the next few years, actively-managed funds won’t earn high enough capital gains to overcome their expenses. And yield spreads between different types of bonds are getting smaller and smaller. The advantages of active management are shrinking.

Bond index funds don’t have a load and have rock-bottom expenses. The number of trades are minimized, and you won’t lose a lot of money from the manager guessing wrong about interest rates. Vanguard is the leader in index bond funds. Vanguard Total Bond Index gets you in a diversified portfolio of most types of bonds. You won’t take much risk, and you’ll get a solid yield.

Buy them yourself. I used to discourage investors who wanted to purchase individual bonds. A bond broker takes bonds the firm has in inventory. You pay a markup over the firm’s cost and the market price. The broker could charge a commission on top of the markup. Almost always an individual investor never knew about the markup or how much it was.

That’s why I used to tell investors who wanted to buy bonds that they should call at least three brokers to get quotes and determine a fair price. That meant you needed accounts at three brokers and had to have the time to make the calls for each bond.

Now there are many ways you can be sure to buy bonds at fair prices.

You can go to a few web sites (see the box). At these web sites you can see the real-time market prices of bonds and determine what you should pay for them. You can place orders through a web broker for reasonable or low commissions. But the brokers still might be selling you bonds out of their inventory and won’t disclose the markup. That is not much of a problem if you’ve looked at market prices for the bonds and determined what you want to pay for them.

Individual treasuries or tax-exempt bonds can be purchased safely through brokers by most investors now. You probably only need about $50,000 to get a diversified portfolio. These markets are developed enough that they are fairly efficient. There shouldn’t be big price spreads for the same bond. But the bond market still isn’t perfectly efficient. You should check the Bond Market Association web site (www.investinginbonds.com) for yesterday’s wholesale prices on corporate and tax-exempt bonds before making a purchase.

Also, I still believe that individual investors should not buy corporate bonds themselves. Those markets are skewed to the big institutions. You need at least $300,000 to get a diversified portfolio at good prices, and research is not easy to do. Stick with funds for these bonds.

Bond Research & Trading Siteswww.bondagent.com
Markup not disclosed. No commission, but $25 fee is fewer than 25 bonds. $10,000 minimum.
www.discoverbrokerage.com
Markup not disclosed. Commissions start at $14.95. $2,000 minimum.
www.etrade.com
Full range of bonds. Markup not disclosed. Commissions start at $25. $1,000 minimum.
www.quick-reilly.com
Treasuries only. $50 per transaction. No minimum.
www.schwab.com
Commissions vary by type of bond. Discounts for online trades. $5,000 minimum. New sites and features due soon.
www.publicdebt.treas.gov
No commission. $25 annual for accounts over $100,000. $1,000 minimum for most debt.

Buy direct. There’s no reason now to pay a commission or mutual fund fee for treasury bonds, unless you want to be able to sell the bond instantly. The Treasury Direct program for buying bonds straight from the Treasury has improved greatly. The minimum purchase for most bonds is only $1,000. You can buy through the mail, over the phone, or through the web. Payment can be deducted directly from your mutual fund, broker, or bank account. There are no commissions. Only accounts over $100,000 pay an annual fee – a mere $25. You can set up a joint account, custodial account, corporate account, or IRA. And you can check your account balance at any time over the web or the telephone.

Finally, you can sell your treasuries easily if you don’t want to hold until maturity. You have to send in a form to make a sale. Then the Chicago Fed gets three bids, sells to the highest, deducts a $34 fee, and deposits the net proceeds in your bank account. It takes about 24 hours.

To get started, write your nearest Federal Reserve, call 202-202-874-4000 (then enter 1, then 241), or check the web site www.publicdebt.treas.gov.
Another advantage of buying individual bonds is that you control the tax burden. A bond fund might sell bonds during the year and distribute capital gains to you. That could push you into a higher tax bracket and is in addition to taxes on your interest income.

If you buy individual bonds, buy a ladder of bonds. That means spread the maturity dates over about 10 years. If you have enough money to buy 10 bonds, buy a one-year, a two-year, a three-year, etc. Then as the one-year bond matures, buy a new 10-year bond. That smooths out the effects of fluctuating interest rates and gives you a yield approximating that of the five-year treasury. Research shows that an individual investor who pays no expenses and sets up a ladder of treasuries that approximates the five-year treasury bond’s yield can beat the after-expense total return of most bond mutual funds. In a low-yield world, the best way to increase your income is to take matters into your own hands and cut expenses to the bone.