Interest rates remain low, and the yield curve remains flat. As I write this, the 10 Year US Treasury yield is about 1.56% and the 2 Year is 1.37%. While they are not inverted, there is speculation that the rates might invert soon. Sluggish worldwide economic growth and particularly uncertain economic growth in China due to Coronavirus are cited as reasons for continued low rates.
Borrower or Lender?
Low rates are great if you are a borrower. If you are looking to buy or refinance a house or condo, mortgage rates are very favorable. If you are in the market for a new vehicle, Toyota, for one, is offering 0% interest rate loans. However, if you are a lender, meaning you are looking to purchase bonds from the US Government or from any other lender or bond issuer, low rates mean that you won’t get a whopping return for the money you lend. 1.56% for locking up your money for 10 years doesn’t sound great, but at least it is a positive return and the money is safe.
Because the yield curve is flat, rates at the short end are almost as high as the long end, so why lock in your money for the long term? My recommendation is to keep your money in a Money Market account, which can pay up to 2% depending on the institution. You may have to be proactive to make sure your money at your bank is earning money market interest or to make sure excess cash in your brokerage account is swept into a money market fund, but the extra earnings are worth the trouble.
Corporate bonds are a higher-paying but somewhat riskier alternative to US Treasuries. To mitigate the risk, I strongly recommend a corporate bond ETF such as the Vanguard Intermediate-Term Corporate Bond Index ETF, ticker symbol VCIT, which currently yields over 3%. There are several alternatives to VCIT but stay with a strong name and something you can easily buy and sell.
Lower in priority than bonds but higher than common stock, preferred stock is another alternative to bonds for current yield. Again, I recommend a fund rather than an individual company’s preferred shares. The SPDR Wells Fargo Preferred Stock ETF (PSK) for instance is currently paying over 5%.
Dividend stock funds pay somewhat less than preferred stock funds in part because qualified common stock dividends are taxed at a lower rate than preferred dividends, which are taxed at ordinary income rates.
I love writing covered calls, especially during choppy markets such as we currently have. When markets are setting all-time highs, I like writing calls at strike prices above these all-time highs in order to generate more current income. I like that I can participate in some upside but get paid currently for giving up a part of the upside that is already above an all-time high.
The most prominent asset class that generates current income is real estate. You can either buy a rental property or a few, or you can buy shares in a REIT or a REIT fund. REIT dividends are not “qualified” for preferential tax treatment, so look for a REIT fund that pays somewhat higher than a stock dividend ETF. Unless you feel you can add value by being a landlord (such as you are handy and enjoy dealing with household maintenance and repair), then a REIT is a better way to own real estate. As to other income-producing alternative assets, annuities remain popular for some, particularly for those desirous of very stable income. Unless you truly cannot deal with any variation in your monthly income, then I recommend you avoid annuities.
All of the alternatives to US Treasuries (or bank-insured CD’s and the like) involve taking on additional risk with your investment. Please be sure you understand the additional risks you are taking on and think about buying funds in order to mitigate these additional risks. Please contact me if you want help in understanding these additional risks.