If there ever was a time for income-producing investments, that
time is now. Thankfully, there's an expanding array of fixed-income
ETFs on the market these days that can help investors cope in a
variety of ways with a stock market rally that seems to have
Indeed, U.S. stocks have officially entered into correction mode in
May as volatility increased dramatically. Through the first five
months of 2010 the S&P 500 is down 2 percent, and I wouldn't be
surprised if the broad-based index finished the year close to
So long-term investors find themselves at a crossroads because
stocks remain attractive fundamentally, but the day-to-day
volatility is just too much to stomach. This is where
diversification and exposure to income-producing ETFs become
An income-producing ETF is especially attractive when the
overall market is flat to down because the regular dividend
payments help boost performance. Most economists were already
predicting modest growth over the next two years even before the
uncertainty in Europe took center stage, meaning the guarded growth
projections might end up looking overly optimistic.
The challenge is that the bull market in bonds since the early
1980s seems to have all but run its course. The Federal Reserve
lowered official short-term interest rates to just about zero after
the economy collapsed in 2008, meaning finding attractive yields in
the bond market these days takes a discerning eye and an appetite
for a little bit of extra risk.
Not Just Guvvies Anymore
In the past, when the words "dividends" and "bonds" were uttered
in the same sentence, it typically referred to government bonds.
Unfortunately for investors, the attractive yields of years past
are no longer available in U.S. government bond ETFs.
The current yield on the Barclays 7-10 Year Treasury Bond ETF
(NYSEArca:IEF) is a paltry 3.3 percent.
Investors could increase the yield to 4.0 percent with the
Barclays 20+ Year Treasury Bond ETF (NYSEArca:TLT), but that's
hardly a risk-free bet. The odds of interest rates increasing in
the coming years is very high, and holding longer-dated bonds when
rates are rising means getting hit by falling bond prices and being
saddled with debt that isn't yielding as much as newly issued
bonds. That's why I have close to 0 percent exposure to government
Corporate Bond ETFs
If the goal is to generate income with a higher yield, it's
imperative that investors take a look at what's going on with
corporate bond ETFs. The more stable investment-grade sector offers
a number of options for investors.
My firm owns shares of the iShares iBoxx $ Investment Grade
Corporate Bond ETF (NYSEArca:LQD), which yields 5.3 percent and
invests in more than 400 bonds issued by corporations whose debt is
considered investment grade by ratings agencies.
If you're like me, you might want to take a higher amount of
risk with a portion of your principal in exchange for a higher
reward potential. I'm talking about double-digit yields, and the
place to find those is in high-yield corporate bond ETFs, also
known as junk bond ETFs.
One of my firm's biggest winners over the last year has been the
SPDR Barclays Capital High Yield Bond ETF (NYSEArca:JNK), which is
currently yielding 11.3 percent. JNK is composed of 140 bonds rated
"BB" or lower, with three-quarters of the allocation in the
Alternative Bond ETFs
A number of other options are available outside of the
traditional bond ETF sectors, including foreign bond ETFs from both
emerging and developed markets, municipal bond ETFs and convertible
bond ETFs, among others.
Instead of investing in emerging market stock ETFs, an investor
can choose the PowerShares Emerging Markets Sovereign Debt ETF
(NYSEArca:PCY), which is now yielding 6.3 percent. Among the
countries represented in the fund are Vietnam, Russia, Uruguay and
Municipal bond ETFs have the benefit of being tax free for most
investors when purchased in a taxable investment account. (But
please verify that before you buy, because there are
One of my favorite ETFs for investors who want a stable monthly
income in a taxable account is the Market Vectors High-Yield
Municipal Index ETF (NYSEArca:HYD), which currently yields 5.8
percent. Because the payments are nontaxable, the tax-equivalent
yield for an investor in the 35 percent tax bracket is 9.0 percent.
There's a risk here because it does invest a large portion of its
assets in below- investment-grade municipal bonds that could be at
risk of default. But that's where the beauty of instant
diversification of an ETF comes into play.
High Yields In A Low-Yield Environment
I'm guessing some of my readers are either retirees or near
retirement age because it's only natural for investors of that age
to focus on bond ETFs.
Unfortunately, as I already mentioned, the search for
decent-yielding ETFs isn't easy in the current low-yield
environment. That said, some of the ETFs I identified make it clear
that exchange-traded funds have kept real the prospect of finding
investments that generate relatively decent income and capital
appreciation at a time the stock market's volatility is dredging up
memories of 2008.
Matthew D. McCall is editor of The ETF Bulletin and
president of Penn Financial Group LLC, a Ridgewood,
N.J.-based wealth management firm specializing in investment
strategies using ETFs.
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