Answers to Your Income-Investing Questions

"Cash in Hand" topics -- bonds, dividends, and other sources of investment income -- are complicated and time-sensitive, so I know you want quick service. I’ll try to answer your questions promptly, either personally or in my "Cash in Hand" columns. I sincerely hope many more of you will write me at jkosnett@kiplinger.com. Here’s a sampling of recent questions and my answers:

Reader's Question: My wife and I put $10,000 in a CD last year and received only a 1% return. We want to invest in something that has a higher yield but little risk. We have been told bonds would be best, but we’re not sure. Can you help?

Jeff's Answer: This is the question on everyone's mind. My suggestion is a combination of dividend-paying stocks and corporate bonds. Vanguard Wellesley Income Fund (symbol VWINX; current yield 2.9%), which owns both of these, is a one-stop solution. It’s had only three down years in the last 20: 4% losses in 1994 and 1999, and just a 10% loss in the 2008 implosion. The fund has had an annualized return (which includes yield from dividends and income, plus price appreciation of the stocks and bonds it owns) of 9.2% over the last 20 years. That’s a great return for relatively little risk.

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Both Fidelity and Vanguard GNMA funds yield over 4% with no withdrawal fees. Are they a good alternative to CDs? Yes, but timing is an issue here. Ginnie Maes are mortgage debt backed by the full faith and credit of the U.S. government. If you’ve owned them for a long time, keep them. But buying now would mean you’ll be investing in pools of mortgages issued at some of the lowest interest rates on record. If you like GNMAs, wait for 30-year mortgage rates to go a percentage point higher. Then resume feeding in money, slowly and regularly. Any low-cost, no-load GNMA fund will do, such as Fidelity GNMA (FGNMX) and Vanguard GNMA (VFIIX).

In September, I put about 5% of my long-term holdings into a municipal-bond exchange-traded fund. I had never owned bonds before. Is this an ill-timed trip? Or, if this is for five years or longer, is it a good move? If you are in a high tax bracket, munis are an excellent value, since they yield more than taxable Treasuries and CDs even before the tax break. Funds and ETFs that invest only in high-quality municipal bonds are fine. Avoid any muni fund labeled high-yield, because these funds invest in bonds backed by business projects that are at risk of default. If you stick with bond funds that invest in water, sewer, schools, highways and general obligations, you can be confident that over the next five years, whatever interest rates do, you’ll get good income. And tax rates aren’t going down.

I am in my seventies and a very conservative investor. My son-in-law, who is a broker, suggested that I put $50,000 into a new issue of a (non-traded) REIT. I am skittish about this. The money is now in Treasury bills. Should I go with my gut feeling and not do it? Trust your gut. There are no good reasons to invest in REITs sold by brokers for commissions -- and many bad ones. Such REITs are not publicly traded, so you cannot freely get your money out if you need it. I’m getting many questions about these private REITs because brokers are vigorously selling them based on 7% annual cash distributions. But fees and commissions eat into that, and selling them if you need the money quickly is a problem.

That said, all REIT investments are not doomed in 2011. If the economy really does improve, jobs pick up and interest rates don’t go much higher, proven publicly traded REITs such as Realty Income (O), Federal Realty (FRT) and Vornado (VNO) will do fine. So will REITs that own apartments. Or use a broad real estate ETF or mutual fund. Either way, you have moderate risk and can expect a 4% to 5% yield. That isn’t bad, though I think utilities are a better idea for 2011.

I am retired and interested in finding an investment that yields a high dividend. All the information about Annaly Capital Management (NLY) seems to be positive. What’s your opinion? It’s one of my all-time favorites. Annaly is a REIT that owns mortgages instead of buildings and has an astonishing record, with a ten-year annualized average return of 13.8%, a steady share price and a dividend yield that usually runs 10% to 15%. It does this by borrowing at low short-term interest rates and buying mortgage-backed securities that are guaranteed by the government. The profits come from the gap between the low cost of its debt and the higher rates people pay on their mortgages. The dividends then come out of that profit, and since it’s a REIT, it has to pay high dividends.

So as long as the Fed promises to keep the short-term interest rates it controls near zero, Annaly should continue to be a great investment. If the Fed starts tightening credit, Annaly will make much less money and will have to cut dividends. Then you’ll want to get out. Buy it -- but don’t go to sleep on the Fed.