Now that MAY is behind us, we can focus on income investing “WITH VIGOR,” to quote JFK whose birthday we celebrated this week. Generating investment income in 2014 is harder than ever because the government is artificially holding interest rates LOW. We agree with their reasoning: Low interest rates promote growth in our economy. That said, it makes income investing challenging because money market funds return zilch…and CDs return less than zilch.
Remember back in 2006 when you could safely park $100,000 in a CD at 5.25% and earn $5,250 a year? Today, that same CD returns only $390 a year. Times have changed as investors seeking safe and predictable income are pushed to invest longer term and accept lower credit quality to replicate the same cash flow. Therefore, it is now timely to remain prudent and carefully pick and choose spots; realizing not all high yielding investments are the same, just as the time periods in putting money to work in the interest rate cycle are not created equal either.
At the end of 2013 with the 10-year Treasury Yield up against 3% for the first time since 2011, we saw tremendous value in the bond market as we published in our newsletter. Just as the Wall Street masses were calling for higher rates, we took a contrarian position because we saw lower rates coming in 2014. Treasury yields have since retreated back down to levels where the value we saw at year end no longer exists. Subsequently, bond prices are up nicely with the downdraft in rates. As we wrap-up May, bonds have outperformed stocks year-to-date presenting a very different script from last year.
Our diligence uncovering creative alternatives to produce ample cash flow have been gratifying. Money can be made in Real Estate Investment Trusts AND Master Limited Partnerships AND dividend paying stable stocks. All three of these investment vehicles are SMART MONEY but STOCKS have proved the best bet so far, especially ones which raise their dividends each year. You may recall that dividends now come in 2 flavors: QUALIFIED, thus taxed at 20%, not your normal bracket, AND UNQUALIFIED thus taxed as ordinary income. The dividends you receive from common stock are QUALIFIED thus taxed at the maximum of 20%. Capital gains are also taxed at this lower rate if you hold for one year plus one day!
In closing, most of our long bond positions can continue to ride because they have been carefully chosen at opportune times over the past few years and continue to pay nice cash-flow. With interest rates back down at the lower end of the range, we remain on watch for possible re-entry into our bond hedging program. Stay tuned.
By: Mike Harris