4 Strategies for Getting More Income
Ron DeLegge, Editor
November 17, 2009
SAN DIEGO (ETFguide.com) – These are trying times for income oriented investors. Interest rates are still stuck at record low levels which means lower income generated from bonds and other fixed income investments.
U.S. Treasuries with a 10-year maturity are yielding around 3.5%, which isn’t much over the lifetime of the investment, especially after deducting the cost of taxes and any potential for re-inflation. The interest rates being paid by bank certificates of deposit (CDs) are also significantly depressed.
What can you do to generate more income from your investments?
Avoid Blow Ups
Many investors have completely wiped out their chances of getting a decent income from their investments because their portfolios have been cut in half or more. Perhaps they made the mistake of investing too much of their money in individual stocks and bonds whose value has evaporated into thin air. Others threw caution to the wind by not using simple techniques to guard against catastrophic losses.
Stop/Loss orders are one strategy for preventing your market losses from getting out of hand. For example, if you bought the SPDR Gold Shares (NYSEArca: GLD) at a market price of $95 per share you may decide to place a 5% or 10% downside floor on your purchase. A stop order to sell an ETF happens at the market price once the ETF has traded at or through your specified price. (Also known as the “stop price.”) If you’re going to get more income from your investments, you need to protect your principal.
Keep Your Investment Costs Low
What if mutual fund investors started looking at their fund expenses as a percentage of the income they’re forfeiting to Wall Street’s money managers? What would they find? Let’s look at two examples.
The Fidelity Dividend Growth Fund (Nasdaq: FDGFX) is a textbook example of how fund expenses can erode your income. FDGFX currently carries a 1.05% yield, but 61% of that yield is being devoured by the fund’s 0.64% annual expense ratio! In contrast, the Vanguard Dividend Appreciation ETF (NYSEArca: VIG) carries a higher dividend yield of 2.24% with lower annual expenses. If you want higher income, switch your investments to funds and ETFs with lower costs.
Here’s one more example of how investment costs can erode your portfolio’s income.
While the American Funds Income Fund of America (Nasdaq: AMECX) has a respectable yield in the vicinity of 5.14%, the fund’s 5.75% up front sales load wipes it away. The fund’s annual expense ratio is 0.64% which represents a 12% give away of its current yield to American Funds’ managers. The SPDR S&P Dividend ETF (NYSEArca: SDY) would be an ideal replacement for AMECX. SDY carries a yield of 4.27% with lower annual expenses of 0.35%. Over the past 2-years, both funds have delivered similar performance returns too.
Focus on Dividend Paying Sectors
Another way to capture more income is to position your investment portfolio in industry sectors that pay dividends. Examples of sectors that pay high dividends relative to the market are real estate investment trusts or REITs (NYSEArca: VNQ), utilities (NYSEArca: XLU) and financial stocks (NYSEArca: XLF).
The Jobs and Growth Tax Relief Reconciliation Act of 2003 made dividend investing that more attractive by lowering the tax on qualified dividend income to a 15% federal rate (currently 0% for taxpayers in the two lowest tax brackets). The lower tax rates apply to qualified dividends received on or after January 1, 2003 and during taxable years beginning before January 1, 2011.
Here’s a few caveats: Dividends received from REITs are not considered “qualified dividend income” and are therefore ineligible for the 15% rate. To obtain the favorable tax treatment from qualified dividends the income must be from domestic corporations and certain qualified foreign corporations. Also, required holding periods of your securities must be met.
Lastly, don’t make the mistake of focusing on sectors that pay high dividends. Make sure the companies within the ETF have enough earnings stability to sustain current dividend yields.
Using Call/Put Options on ETFs
One last way to generate more income is by using option securities. A commonly used options strategy is to sell covered call options. This allows an ETF investor to generate income on their ETF holdings and to offset any potential market declines
In the March and April editions of our ETF Profit Strategy Newsletter, we highlighted four key ETF options strategies. We explained the basics of how call/put options work and gave specific examples of ETF option strategies executed.