A year ago, I wrote that 2013 would be a
mostly stable year for income investors
, with yields creeping up but not soaring. That's about how things
turned out, though interest rates eventually rose more than I
expected. As a result, you may have lost 1% or 2% in a diversified
bond portfolio. I see rates climbing in 2014, but again, not by
Where they go may depend on the resilience of the "Great
Rotation," one of the big investment stories of the past year. The
idea is that income investors, worried about the prospects of
losses in their bonds (whose prices generally move in the opposite
direction of rates), bailed out of fixed-income holdings and put
the proceeds into shares, adding fuel to 2013's surging stock
It's a compelling story line, but I'm not persuaded that stocks'
big year came at the expense of bonds and other yield-focused
investments. Sure, bonds, real estate investment trusts and
preferred stocks suffered through a rough patch in the middle of
2013. But those and other income investments rebounded in late
summer and early fall of 2013. Even Treasuries, which led the bond
market down in the spring and summer, have regained some lost
value. The yield on the benchmark ten-year Treasury, which peaked
just below 3% in early September, stood at 2.6% on November 1.
The take-away: There's a huge difference between the end of a
bull market in an investment class and the onset of collapse. Bonds
and bond substitutes won't deliver big total returns in the coming
year, but they won't cause you to lose sleep worrying that your
principal will melt.
That said, you don't want to own too many Treasuries and
Treasury-heavy bond-market index funds. The income is too puny.
Plus, Treasuries will likely see another year of losses as yields
resume their rise once the Federal Reserve finally starts to trim
its $85-billion-a-month bond-buying program. Figure that the yield
on the ten-year Treasury will hit 3.3% in 2014.
The biggest losers from the Fed's easy-money policies continue
to be people with big bucks in money market funds and CDs. The Fed
isn't likely to lift short-term rates until 2015 at the earliest,
so expect another year of zero returns for cash-type investments.
That means a loss after inflation, expected to ring in at 2% in
Tax-free treats. There are some good opportunities in income
investing, though. Municipal bonds remain one of the most
attractive fixed-income sectors. You can choose from an ocean of
sound munis that yield 100% to 110% of what Treasuries of
comparable maturity pay. Because muni interest is generally free
from federal (and often state and local) income taxes, you can see
why they're a good deal.
As for taxable bonds, I continue to favor single-A- and
triple-B-rated corporate debt. On a total-return basis, these
investment-grade corporates roughly broke even the past year, their
income offsetting mild declines in principal. I also like
floating-rate bank-loan funds, which are yielding 3% and up and
hold up well in a rising-rate environment (see
Get 3% With Low Risk Via Floating-Rate Bond
If you're hoping for a sure-shot, big-money tip for 2014, you'll
be disappointed. Nothing is severely undervalued. My best tip is to
fish in the deep pool of closed-end income funds whose share prices
are languishing well below the value of their underlying assets.
Two that have recently swung from selling at premiums to their net
asset value per share to discounts are BlackRock Limited Duration
, $17) and John Hancock Income Securities (
, $14). The funds, yielding 7.5% and 6.4%, respectively, use
borrowed money to boost income. In both cases, the funds'
investment earnings cover their payouts.