One of the most consistent questions I get from friends, readers and acquaintances is, what to do if you or your parents need to live on investment income? You cannot use Treasuries or certificates of deposit, as had been the case for decades leading up to the recent credit crisis.
Historically, safe, fixed-income investments were not making you rich, but most of the time you could find quality that could generate cash. But now that rates are held at near zero and fiscal policy is pressuring longer-term rates, that's not a viable option for most folks. I am continually surprised that senior citizens are not yelling louder than the Occupy crowd at the damage the current policy has done to savers and fixed-income investors.
Choices for fixed-income investors who need the regular cash flow are pretty limited. I continue to believe that high-yield bonds are just too risky for a large allocation by fixed-income investors. Municipal bonds seem to have shed some of the default risk, so cherry-picking municipal funds and individual offerings can benefit taxpaying fixed-income investors. Mortgage real estate investment trusts such as Annaly (NLY) can help ratchet up the yield, but in these times of tightening spreads they can be very volatile, so only a small exposure is appropriate for conservative investors.
The answer, as it has been for the past few years, is that you should buy higher-yielding stocks to provide a flow of cash that can allow you to live off your savings and investments.
In the first part of this week, I want to spend a little time on income investments. Although it may not be a hot topic for those of us who trade and invest on a daily basis we all probably have friends and relatives facing the challenges of fixed-income and retirement-income investing. It requires a change in mind-set for most fixed-income or bank investors.
Stocks are not guaranteed by the U.S. government, and the total values on your statement will fluctuate far more each month than you have experienced with fixed income. In order to generate enough money to replace those 5% and 6% CDs and Treasuries you bought in the first part of the decade, you will need to tolerate more volatility. If you pick solid stocks and have a long time frame, I do not necessarily believe you are increasing your real risk, but stocks do fluctuate more than bonds or bank instruments.
I will start the discussion today with the super-safe stocks that can be the core of an income stock portfolio. AT&T (T) is yielding almost 6% at the current levels, and the company is financially solid. The attempted acquisition of T-Mobile is going to settle in court sometime next year and could create some volatility in the shares as the headlines become known. The landline business is settling down and showing some signs of stabilizing, and the wireless side of the telephone business should continue to grow.
As long as I have been in the business, income portfolios have contained drug stocks, and this time is no different. What is different now is that most of the major U.S.-based drug companies are fairly valued or overvalued and are facing significant patent expirations. At these levels I prefer stocks such as GlaxoSmithKline (GSK) and Sanofi (SNY). Most of Glaxo's patent issues are behind it, and it has several promising drugs in the pipeline that should reach the market by next year. At the current price, the shares yield almost 5%, and the company should be able to increase the dividend in excess of 5% annually.
Sanofi's purchase of one of the leading biotech companies this year should pay off for the company starting next year. Sanofi does have patent issues that will last for a few more quarters, but the portfolio of new drugs from Genzyme should offset that over the next few years. The stock pays a 5.1% dividend at today's price, and dividend growth should also be above a 5% annualized pace for the company.
Although these stocks have rock-solid financials and stable dividends, do not just buy them blindly. Always make Mr. Market work for you by buying on down days and scaling into your purchases. Tomorrow I will look at some dividend stocks that are not as well-known but can still offer steady cash flows with a margin of safety of investors who need income.