Ways to Play It Safer in the Search for Extra Yield

Jason Stipp: I'm Jason Stipp for Morningstar. In this difficult yield environment, we know that investors are searching high and low for a little bit of extra income. Morningstar's Christine Benz, our director of personal finance, recently did a video talking about some yield traps, some areas you want to avoid in this endeavor. But she is here today to talk about some safer ways to pick up a little bit of extra yield.

Christine, thanks for joining me.

Christine Benz: Jason, nice to be here.

Stipp: So, the first thing that I want to touch on is that, for some of these suggestions we're not saying dump every income investment that you have right now and buy all these because of the extra yield. How should you think about these ideas before we get started?

Benz: Right. So I'm not saying to completely redo your asset allocation. So a couple of the ideas I have are stock related. I'm not saying that dividend-yielding stocks are an appropriate substitute for bonds. These are mainly things you can do around the margins of your portfolio.

Stipp: So you mentioned stocks. I think it's a good place to start as a potential income booster for your portfolio. What are you seeing as a good way to do that when you are looking at the stocks front?

Benz: Well, I was very compelled by Josh Peters' video this week talking about the dividend yield on Johnson & Johnson stock versus what the new bonds are yielding and how you are actually picking up a higher yield on the stocks than you are in the bonds. It's not something that you typically see--not a relationship that you typically see. And of course, the risk potential of the stock is much higher than the J&J bond, but you do have some capital appreciation potential plus that higher yield, which could be little bit of a cushion even if J&J stock lost money.

So, not just with J&J, but looking at high-quality dividend-paying stocks across the board I think can be a very good strategy. You can pick up a little extra yield and also get some capital appreciation potential.

Stipp: So if you're on Morningstar.com, what's a good way to start to narrow down some of those higher-quality choices?

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Benz: I just did this, Jason. So I screened on wide-moat, 5-star stocks that have dividend yields above 3%, came up with 11 companies. It's a really high-quality basket of companies there. So you've got companies like J&J, Abbott Labs, Novartis, Paychex, Home Depot--brand name companies.

Stipp: The second idea that you have is in the mutual fund area. I know that we've seen a lot of interest in Treasuries, especially as the market has hit some rocky road recently, and we've seen yields on Treasuries really, really low, hitting historical lows in some cases on certain days. What's your advice for folks who are looking at mutual funds and want to try to pick up a little bit of extra income?

Benz: Right. It's interesting, Jason. I think that there are some momentum forming around this idea that maybe we are in a little bit of a bond bubble, particularly in the realm of high-quality bonds. So I don't think it's an unreasonable time to start thinking about downplaying government bonds and Ginnie Mae bonds as a percentage of your portfolio and potentially looking to a fund that puts a greater emphasis on corporates and asset-backed bonds, and you will be able to pick up very likely 1 percentage point in yield, and in the low-rate environment, that's actually pretty appreciable in percentage terms.

So, a couple of funds I like in this realm would be MetWest Total Return, Metropolitan West Total Return, also Dodge & Cox Income, both of which have that emphasis and tend not to emphasize Treasuries, at least not right now.

Stipp: So certainly have the flexibility and a really good manager who can manage in this very difficult environment.

Benz: And low costs.

Stipp: The last thing also sort of brings taxes into the equation, and that's when you are looking at the different options that you have in fixed income. There are some good opportunities potentially in munis right now. What are you seeing there?

Benz: I think so, Jason. So I recently hopped on to Vanguard's site, and I like to compare their intermediate Treasury fund with their intermediate-term muni fund. And what you see is that you are actually getting a higher yield on the muni fund on a pre-tax basis versus the Treasury fund right now. And of course, here's another situation where there is little bit of a risk mismatch. So the risk is obviously much less in the Treasuries than is the case in munis given the trouble that some state and local municipalities are in.

But I still think that if you go for a widely diversified muni fund, keep the cost nice and low, look for a fund that emphasizes high-quality munis that that's kind of a safe tradeoff to make right now versus opting for that Treasury-only fund. Look to a muni fund particularly if you are in a higher tax bracket or if you think tax rates will go higher in the future, which I think is a reasonable bet to make.

Stipp: Well, Christine, thanks for giving us these tips to maybe play it a little bit safer as you are looking for a little bit of extra yield.

Benz: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.