Income Strategies for Volatile Times: Munis, Treasuries and Bond Ladders

Given the market's recent volatility, it is not surprising that several conservative investment experts have been highlighting low risk, fixed-income opportunities. Four MoneyShow.com contributors discuss a variety of strategies to help balance the equity risk of one's overall portfolio. Michael Foster, Contrarian Outlook There's an easy way to weaken Uncle Sam's grip on from your income stream. I'm talking about municipal bonds, or bonds issued by states, cities and counties to finance roads, bridges and other projects. Why muni bonds? For one, they pay a steady dividend that's entirely tax-free for most Americans, meaning you can keep 100% of your gains forever. Second, your muni income won't bump you up into another tax bracket, another win that few folks pay much attention to. The best way to buy munis is through closed-end funds (CEFs), because CEFs let us buy these bonds at big discounts while enhancing the tax-free dividends they hand us. With that, let's dive into five cheap muni CEFs throwing off healthy income streams now. Nuveen Michigan Quality Municipal Income Fund As the name suggests, Nuveen MI Quality Municipal Income Fund focuses on bonds issued by the state of Michigan (or Michigan's counties, cities and other state-level organizations). Nuveen MI Quality is a rare gem with a tremendous track record -- it's up 8%, on average, per year over the last decade, with a 4.1% dividend stream. That's way more than the 1.8% you'd get from average S&P 500 stock, and it doesn't even include the effect of the fund's tax-free status! Amazingly, this one trades at a massive 13.6% discount to net asset value, or NAV, as I write, though that deal is fading fast. With this narrowing discount, investors are bagging a big profit (for relatively stable investments like munis), with 7.3% total returns for 2019 already. More gains loom as the tax-weary hordes swoop in over the next few weeks. Beat them to the punch and grab this fund now, while it's still cheap. DTF Tax-Free Income Fund Inc. Now let's invest beyond Michigan with DTF Tax-Free Income Fund. Its multi-state approach means it holds bonds from across the country, with its biggest holding at just 3% of its portfolio. And with a 12.3% discount, it's similarly discounted to NUM. The yield here is a bit smaller -- just 3.2% -- which is the price of this diversification. But DTF Tax-Free's track record more than makes up for this: The fund has returned over 80% in the last decade. Although not all of those gains came in the form of tax-free dividends, DTF Tax-Free investors are up solidly over the long haul, and they're getting paid tax-free income as their principal grows. Delaware Investments National Municipal Income Fund If big income is what you crave, the 4.7% dividend yield on Delaware Investments National Municipal Income is for you. Despite the name, the fund doesn't invest in Delaware (that's the name of the company managing the fund). This is a multi-state muni CEF with no more than 2.3% of its assets in any one muni bond. Its 11.5% discount has been gradually slipping, after suddenly widening in February. That's all thanks to price gains, as the fund's shares are up 8.4% for 2019 -- but there's much more to come. Why? Because the fund's average discount to NAV over the last decade is just 8.5%, and with its income stream stronger than ever, there's little reason for its current 11.5% discount to stick around. Plus, the fund's 6.5% annualized return over the last decade proves it can cover its dividend and hand you some nice gains, as well. Western Asset Intermediate Municipal Bond Fund Western Asset Intermediate boasts a 12.4% discount while handing you a nice 3.8% dividend stream. But its history is what really stands out. This fund goes back to the early 1990s, and its total return has been staggering over that time. If you want an income stream, but you don't want the headache of worrying about when to sell a fund -- or if the fund should ever be sold -- SBI is a good choice. It has also been outperforming the benchmark iShares National Muni Bond ETF since the ETF came out in 2007, indicating that its managers are no slouches. If you need a long-term income stream without tax headaches, take a close look at SBI. BlackRock MuniYield California Quality Fund Now let's close out with another muni standout. The BlackRock MuniYield CA Quality Fund has crushed the market for a long time. What's more, its 4.6% yield crushes the crummy 2.4% of the underlying muni bond index. Such out performance deserves a premium, but the fund trades at an 12.0% discount to NAV, much lower than its 7% average discount over the last decade. That's a clear indicator that you can grab some upside from BlackRock MuniYield CA Quality Fund if you buy now, in addition to that nice tax-free income stream. Bob Carlson, Retirement Watch We have added Wasatch-Hoisington U.S. Treasury Fund to our model retirement portfolio. The fund owns U.S. Treasury securities and can buy any duration of security. In recent years, its owned primarily very-long-term Treasury bonds. It expects interest rates to remain low and even decline because the economy is weak and inflation is going to stay low. The fund doesn't try to trade short-term market moves or respond to every utterance by Fed officials. It focuses on economic trends and established monetary policy. Last year, the fund insisted the Federal Reserve couldn't maintain its policy of higher interest rates and its management team turned out to be correct. The fund gained 0.79% in the last month and 1.93% for the year to date. The yield is 2.19%. I also recommend Vanguard Treasury Money Market (VUSXX), or its Admiral shares if you meet the minimum balance requirement. Vanguard has the lowest-cost money market funds, and Treasury-only funds are the safest. You might find it more convenient to use a money market fund sponsored by your broker or mutual fund firm. If you want a higher yield, consider a fund that invests in more than treasury securities. The yield is 2.35%. It's added 0.21% in the last four weeks and 0.67% for the year to date. Tim Plaehn, The Dividend Hunter In my earlier days as a financial advisor, conservative fixed-income investors would build a bond ladder portfolio to generate a high current yield, but not have all of their money locked into the long-term bonds, which paid the highest yields. The idea of bond ladders fell out of favor with the rise of bond ETFs and index funds. Bond funds work great when interest rates are declining, which they have been since the U.S. 10-year Treasury reached a peak yield of 15% in Fall of 1981. However, lost in the fog of history is that rising interest rates are terrible for bond funds. In a rising rate world, bond fund prices fall, and by reasons of math and how the funds are structured, cannot recover the lost value. Investors who have put billions into bond ETFs and index funds are in for a rude awakening when the day comes that longer-term interest rates start into an extended up-trend. We have not seen it yet, but everything goes in cycles, and I strongly expect the same to happen with bond yields. The bond ladder strategy avoids the danger of falling bond prices in a rising rate world. That's because the bonds are held until maturity when the face value will be paid off. (That's what could hurt bond funds. They don't hold bonds until they mature). To provide liquidity and an attractive yield, a bond ladder is established by buying a portfolio of bonds with laddered maturities. For example, the investment capital would be split between five bonds, each maturing in each of the next five years. Once the ladder is set up, there will be a bond or bonds maturing every year. The principal can be reinvested at the longest term of the ladder, which when the yield curve is normal, will pay the highest yields. In a hypothetical world of yields that don't change and a positively sloped yield curve, a bond ladder will have an increasing yield over time as maturing bonds get reinvested. If rates are rising the ladder will generate strongly increasing income without putting the principal at risk. A good deal. For our Dividend Hunter Fixed Income Investments, I recommend setting up a bond ladder using the Invesco Investment Grade BulletShares ETFs. These are ETFs which have portfolios of investment-grade bonds with each individual ETF having a fixed maturity at the end of each year. There are separate ETFs with terms of one to 10 years. These funds allow you to set up a low cost, diversified bond ladder. Here are some of the BulletShares features: Extremely stable share prices. The fixed maturities ensure to that. Shares are extremely liquid. ETF shares are easy to buy or sell in your brokerage account. Some brokers (I know Charles Schwab is one) do not charge commissions to buy or sell these ETFs. Monthly dividends. Which can be automatically reinvested to compound the investment returns. Higher yields than you can get from money market types of accounts or funds. And once you buy the shares, yields are locked in until maturity. My recommendation: Put a portion of your portfolio into a five-year ladder of the BulletShares ETFs. I strongly suggest you set up automatic reinvestment of the monthly dividends. I view this portion of your portfolio as a type of emergency fund that you can tap into when the stock market cycles through the next bear market. When stock prices start falling rapidly, you will be better served by reinvesting your stock dividends into shares of our quality dividend paying stocks and selling BulletShares shares for the money you need to pay your retirement expenses. Setting aside money to cover a year of your living expenses could be something you are very thankful for at some period in the future. John Bonnanzio, Fidelity Monitor & Insight As with most things in life, perspective is everything. With the average Fidelity stock fund up almost 19% this year, the 1.3% return of Fidelity Conservative Income Bond doesn't seem particularly alluring. Likewise, Fidelity U.S. Bond Index , up 2.9%, feels like another comparative laggard. While Conservative Income's performance is far from eye-catching, when this ultra short-term bond fund is used as an alternative to a money market fund (which is how we use it in our growth and income and income model portfolios), its appeal becomes apparent, especially for income-oriented investors and those who are nervous about stocks and bonds alike. Between December 2016 and December 2018, the Fed raised rates seven times, from 0.25% to the current 2.50%. As money market funds only hold very short-term paper, their yields move in near-perfect sync with the federal funds target rate. During that same period, for example, the yield on money market (Fidelity's only prime fund that's available to retail investors) rose from a bare-bones 0.54% to its current 2.23%. For the foreseeable future, however, yields on both money funds and ultra short-term bond funds are likely staying put. Though first-quarter GDP accelerated to an annual rate of 3.2%, that figure is both subject to later revisions (up and more likely down), plus a bit of derision from naysayers. (Some pundits think the rate can't be sustained.) Regardless, inflation is certainly quiescent, and for the time being, rate hikes are on hold. While it's the case that yields on money funds and the Conservative Income fund and its tax-free counterpart Fidelity Conservative Income Municipal Bond Fund -- have barely budged, further out on the yield curve fixed-income investors are hardly being paid much of a yield premium for assuming additional interest-rate risk. That takes us back to both our ultra short bond funds! (For ease of comparison, we'll stick with the taxable variety.) While Fidelity's taxable money funds are yielding a hair's-breadth above 2%, Conservative Income yields 2.51%. And whereas Fidelity's Money Market Fund offers no opportunity to appreciate in value, Conservative Income can provide modest upside potential. So far this year, it's up 1.3% whereas Fidelity money market's compounding income translates into a year-to-date total return of 0.7%. Granted, Fidelity Short-Term Treasury Index yields more and has a better total return, but that's because it has substantially more rate-risk (its duration is 2.6 years versus only 0.2 years for Conservative Income). Case in point, Short-Term Treasury's relative volatility (as measured over three years) is 0.14, versus 0.03 for Conservative Income Bond. (Statistically speaking, Conservative Income Muni actually has zero risk, though its steady NAV masks its modest credit-risk.) The bottom line: Fidelity's Conservative Income funds are presently suitable, higher-yielding alternatives to money funds, though they are a bit riskier and may not provide the liquidity of money markets. At the same time, if you're looking at the stock market's meteoric rise this year and have some fears that you are over-exposed to stocks, while not especially enamored with today's bond yields, you are not without alternatives.

Income Strategies for Volatile Times: Munis, Treasuries and Bond Ladders

There are an array of low-risk, fixed-income opportunities to consider for investors seeking shelter from a stormy market.

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