Investing Lessons for Income Seekers

This is my 100th “Cash in Hand” column, counting those that have run in the magazine and those that have appeared only on the Web (see them all). I’d like to mark this milestone by passing on some of the wisdom I’ve accumulated while observing and decoding the world of income investing.

The single most important lesson I’ve learned is that when it comes to income securities, something is always working somewhere. By working, I mean paying dividends or interest on time without causing life-altering losses of principal. The closest we came to a total wipeout was during the 2008 financial crisis. But even then, Treasury bonds and securities backed by the Government National Mortgage Association provided refuge.

I know some of you aren’t interested in oil-and-gas trusts or foreign bonds. You pine for the days when certificates of deposit paid 8% or you could gather the down payment for a house by feeding a money market fund. (I did that 30 years ago!) But those times aren’t coming back anytime soon. The Fed has vowed to keep interest rates low until the tepid U.S. economy picks up steam, and banks have no reason to pay more to attract deposits. A major pickup in inflation isn’t in the cards. So to bring in cash, it pays to learn about and get comfortable with an ever-wider array of investments—sometimes nontraditional ones. That’s what “Cash in Hand” is all about.

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I said I would offer some useful observations. Here goes:

Ignore prophets of doom. No one has harmed income-seeking investors more than rabble-rousing commentators and analysts. From Meredith Whitney predicting a wave of municipal-bond defaults to the demagogues who vilify dollar-denominated assets because they think the buck is headed for oblivion, these permanent pessimists are inevitably wrong.

The best way to build wealth is with a dividend-growth strategy. When you invest in stocks, it’s not always about finding the highest yielders. Even if a stock yields little today, you’ll eventually pull in double-digit income on your purchase price if the company raises its dividends by 10% year after year.

Don’t restrict yourself to funds. Once you’ve boned up on bonds—and especially if you hold some bond funds already—don’t be afraid to add some individual securities. You will save on fund costs and, because you can hold a bond to maturity, you won’t have to worry about interim price swings. And you needn’t fret about what a fund manager does or whether money is flowing out of or into a fund at the wrong time.

For income, Treasury bonds are lame. Starting in 2008, their role has evolved from providing income to being the world’s lockbox. That’s why ten-year Treasuries still yield only 1.7% four years after the Great Recession ended. Bondholders are willingly forgoing income in return for the comfort provided by Uncle Sam’s “full faith and credit.” My main objection to Treasuries isn’t that you’ll lose money if interest rates rise; it’s that their yields are inadequate for your purposes.

Municipal bonds rock. Investors may be overpaying for Treasuries, but they clearly don’t trust states and municipalities. As a result, after-tax yields on muni bonds are far more generous than those of many comparable taxable bonds. But most states and local governments are not in bad shape, and Congress will not invalidate the muni-bond tax exemption. Take all due advantage.

I’ve made some bloopers. In January 2011, I said sell health care real estate investment trusts because of a negative analyst’s report. Since then, health REITs have delivered fine results. There’s nothing I’ve written in these columns that I regret more.