In these times of volatile stock markets and record low interest rates, your clients are probably looking for income wherever they can get it. With exchange traded funds (ETFs), there are a number of ways to generate cash for their portfolios.
There are some clear benefits to this “extra” income, including:
- Timely income distributions help offset an investment portfolio’s hits from other areas of the market, and investors may add another position with the extra cash.
- In retirement, income-producing investments help provide stability to a portfolio and a greatly needed income stream.
Here are a few easy ways to give your clients this exposure.
Fixed-Income
Bond ETFs are one of the easiest ways to get really diversified exposure to the fixed-income market. Just as with equity ETFs, bond ETFs come in all shapes and sizes: total market funds, muni bond funds, short-term Treasuries, sovereign debt and so on.
Bond ETFs bring liquidity and transparency to the general masses that can’t be found in the bond market. These funds pay out monthly or quarterly dividends and any capital gains are paid out through annual dividends.
One issue with bond ETFs to be aware of is that many funds optimize their underlying indexes, meaning that they own a representative sampling of all the bonds in the index. This is because indexes frequently hold thousands of bonds, making it cost-prohibitive to buy them all for the ETF. This optimization can lead to tracking error in bond funds, but the cost of this still does not outweigh the benefits they give in terms of exposure, diversification and income.
As with other ETFs, the biggest tax advantage of bond ETFs is that while you do have to pay a capital gains tax on profits earned from them, you usually only have to do it once the ETF is sold. Certain bonds are taxed differently – such as muni bonds, which have no federal tax – so be aware of the differences and bring it up with your accountant.
Funds that cover the bond market come with a wide variety of investment strategies and yields.
- Broad-based bond ETFs include both government and corporate bonds at varying maturities. The ETFs that come in different maturities can be found in yield-curve bond ETFs that have different target maturity dates.
- Treasury bonds come in both mixed maturities, as well as short-term and long-term. Right now, with market fear higher, investors are pouring into these funds and yields have gotten pushed down around 3%.
- Muni bond funds represent both states and localities. Though yields on muni bonds might be lower, they’re exempt from federal taxes, making that yield more attractive. And if you buy the muni bond in the state or locality in which you’re living, it’s exempt from those taxes, too.
- Corporate bonds come in both high-yield and investment-grade varieties. These kick off some of the nicest yields, which have been seen around 9% to as high as 12%. With that yield, though, comes greater risk of default.
- Sovereign debt funds consist of bonds issued by both developed and emerging markets. Although there’s increased risk in some of these funds, it’s spread out among several governments. In exchange for taking on slightly more risk, there are some attractive yields in these funds, ranging from 4% to 6%.
Experts suggest that you approach bond investing as you would investing in other asset classes. That means, don’t set it and forget it. Not all bonds suit all situations. For example, with interest rates at record lows, long-term Treasury bonds are in favor. But once rates are hiked, long-term bonds may get hit and short-term bonds could be more advantageous.
You can find and sort through all the fixed-income ETF options by going to the ETF Analyzer and selecting “fixed-income” from the drop-down menu. From there, you can sort by performance, yield and more or view the ETF Resume of any fund.
Dividends
Dividends are a sign of a publicly-traded company’s financial standing. If a corporation is maintaining its dividend or even raising it, it’s generally taken as a signal by investors that the company is on solid ground. This often creates a positive cycle in which the company pays a dividend, more investors buy that company’s stock and the stock price goes up, benefiting all the current shareholders.
When most bond yields are as low as they are now, dividend ETFs may be a better option for many investors. And with the markets as volatile as they are now, dividend funds can provide a little stability, since few companies pay dividends if they don’t plan on doing so for the long-term.
Beyond regular dividend-paying companies, there are two types of dividend-payers that are in a class all their own: dividend achievers, which are companies that have raised dividends for the last 10 consecutive years and dividend aristocrats, which are companies that have raised dividends for the last 25 consecutive years.
While yields on dividend ETFs may not necessarily be as high as they would on, say, a high-yield corporate bond ETF, they do provide more stability, consistency and reduced risk for your clients.
Utilities
Utility ETFs don’t scream high performance and robust returns, but they do produce some decent dividends and with relatively low risk. In fact, because the utility sector is less likely to have large market swings, it’s considered a “defensive investment.”
That’s because by and large, the fundamentals are in the utility sector’s favor. No matter what, everyone needs water and electricity. They may scale back usage in tight times, but it would be impossible to do away with utility services completely. Furthermore, most municipalities also let their utilities engage in a local monopoly since it is more efficient to have one company providing all the services in an area.
Dividend payouts provided by utility ETFs are on the low side, but utilities have a history of rising distributions, which also helps lower inflationary risks.
Aside from the broader fundamentals, the case for utilities these days is a strong one. The U.S. electrical grid is notoriously outdated; funding to bring the grid into the 21st Century is in the works. On top of that, population growth in both the United States and overseas is expected to put greater demands on the utility sector.
You can visit the ETF Analyzer and sort the available utility ETFs by yield, which currently range from 3% to 12% for an international utilities fund.