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Top Picks for Income: Readers Name Names

High-yield bonds, REITs, and plain-vanilla dividend payers rank at the top of many lists.

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It's a cruel convergence. Enthusiasm for income-producing investments has rarely been higher, as many investors are in "show us the money" mode following the dreadful market environment of the 2000s. Yet decent yields on securities with a measure of downside protection are tough to come by these days, as a result of the Federal Reserve's policy of keeping interest rates near zero.

In an effort to help yield-starved investors scare up some ideas, I recently asked Morningstar.com readers to share their single favorite income-producing investment. Poster Acruisinglife sees a surplus of choices, quipping, "Tough question. [It's] kind of like asking me to choose my favorite microbrew. There are so many good ones. Can I just opt for the whole liquor store and get them all?" 

Meanwhile, FidlStix's joking post hints that strong and safe sources of income are in scarce supply these days. He wrote, "My favorite is one I can't name, but it cranks out a steady 25% yield, 5% share appreciation, and is immune to the state of the market. When I find it, I'm going to load up on $200,000 worth and rake in a secure $50,000 retirement income."

Bubbygator criticized the whole exercise, saying, "I don't have a favorite--and I don't recommend having a favorite. 'Favorite' implies an emotional attachment"

But responses to my query poured forth all the same, with investors enthusing about leveraged closed-end funds, high-yield and municipal-bond funds, REITs, and master limited partnerships, among other securities.

Of course, one person's sleep-at-night investment can be the equivalent of a triple espresso for another. Moreover, I didn't ask investors to share an investment they would recommend today, and many of the securities they mentioned are rated as overvalued--or at least risky--by Morningstar's stock and fund analysts.

Those caveats aside said, the securities mentioned in the thread could be a good starting point for further research. To read the complete discussion or share your own favorite income-producing investment (remember, just one!), click here.

'True and Reliable Without Much Variance'
Although yields have been shrinking steadily during the past several years, bonds and bond funds received repeat mentions as go-to investments for income.

Echoing a discussion from late last year, Hkong70 noted that I-Bonds purchased back in 1999, with much more favorable interest rates than those on offer today, have been an income-producing investment that has kept on giving. This poster gives credit for the idea where it's due: "I got this information from the Bogleheads forum. Thank you, Mel and Taylor." (Mel Lindauer and Taylor Larimore were among the original contributors to the Bogleheads forums on Morningstar.com as well as Bogleheads.org.)

High-yield bond funds, while risky, were another oft-cited favorite spot for income, with Vanguard's offering receiving repeat mentions. Capttug summarized the case for  Vanguard High-Yield Corporate (VWEHX), which tends to be conservatively positioned within the wild and woolly junk-bond category. "I think of it like an annuity without the cost. It's currently priced at about half of what it was before the crash so there is not as much downside risk. Known for its conservative stance in this market segment makes me sleep well at night."

Gradyman1 has a different pick within the high-yield space:  T. Rowe Price High-Yield (PRHYX), which is more aggressively positioned than the Vanguard fund but more moderate than others in the junk-bond category. He wrote, "With exception of 2008 when all fell down, it has been a solid performer. It's well managed [by manager Mark] Vaselkiv and the rest of the T. Rowe team." (Note that the fund recently closed to new investors.)

Edmund_Dantes' pick, seconded by knobby62, doesn't land in the high-yield bond category, but it does have a juicy yield. He wrote, "My current favorite, given my current, problematic view of the capital markets, is  DoubleLine Total Return Bond (DBLTX). I like it for its barbell positioning between private and agency mortgages, its ability to emphasize one or the other, depending on market outlook, and I admire the long history of the manager and his team on this fund and at their time with TCW."

 PIMCO Income Strategy II (PFN), a leveraged closed-end multisector bond offering, also received more than one mention. Lakeside7 enthused, "[Its distribution] has been recently hiked to over 9% at current price, signaling management confidence in the sustainability of current level of portfolio earnings." 

CKrypton, meanwhile, favors DWS Multi Market Income (KMM), another leveraged closed-end fund in the multisector category. "I purchased this one back in the market lows of 2009. The closed-end fund has come through the crash of 2009 and the current (Europe) crisis so far. I always pick up more shares whenever they pay more than 9% yield. " 

Other posters are fond of municipal bonds and bond funds as a source of income that's easy on the tax return. Aussie0943 notes that individual California general-obligation bonds, purchased in 2009 with 6% coupons, have been favorite income producers. The four-part rationale? "Steady income to maturity. No principal risk if holding to maturity (assuming no default). Interest-rate risk, but not for a number of years at current rates. No federal or state taxes." (Investors only receive a state tax break on their home state's bonds, however.)

Geezette, a holder of individual munis since 1974, is also a fan. Among the positive attributes? "They produce significant income though brokers didn't like me at all. Hold to maturity and have lost nothing (thin ice at times) compared to some junk stocks I own like
 Bank of America (BAC) and
 Royal Bank of Scotland (RBS) preferred. My stocks took a beating in the early 2000s and in '08. Muni funds are too risky if rates start rising."

But posters like carman are just fine with muni funds, thank you very much. Carman wrote
Vanguard High-Yield Tax-Exempt (VWAHX) and
 Vanguard Intermediate-Term Tax-Exempt (VWITX) currently hold a lot of our cash and are paying a nice steady income that is not federally taxable. Taxable-bond funds, money market accounts, and certificates of deposit do not currently pay decent dividends or interest, and what they do is taxed almost to extinction."

JHAsheville concurred about Vanguard High-Yield Tax-Exempt. "It stays true and reliable without much variance."

OceanMinded also likes muni funds, but prefers leveraged losed-end offerings. "My favorite income-producing fund in my taxable account has been Nuveen California Quality Income (NUC). It has a tax-equivalent yield of over 10% for me, pays out monthly, and hasn't been too volatile."

'A Unique and Steady Satellite Investment'
Although Morningstar's equity analysts currently view the REIT sector as the most overvalued in their coverage universe, REITs and REIT funds also received several mentions from income-seeking investors.

Among individual REITS,  Realty Income (O) earned kudos from more than one user.  Weiwentg described it as follows, "Boring, predictable, and so far, as reliable as you can possibly get with an equity."

Multiple posters also gave thumbs-up to Annaly Capital Management (NLY)--perhaps not surprising given its lush yield. Tomarcher wrote, "It is a REIT that owns mortgage-backed securities guaranteed by government agencies. Pays a 13% dividend. Proven management that will avoid a crisis, I hope!" (Morningstar analysts don't currently cover Annaly, but it's safe to say that you don't receive that kind of a dividend without taking on significant risks.)

DaveinPa likes the fundamentals of American Realty Capital Trust (ARCT). "The REIT got started at the right time, bought the right properties, and has the right tenants, of whom 75% are investment-grade and with de minimis lease expirations for years to come."

Danahan has ventured even further afield in the search for income-producing real estate investments. "My wife works for a  Walt Disney (DIS)-owned company where she receives shares of company stock through their profit-sharing plan. When [Disney shares] recently hit a new all-time high, we cashed in a portion of the fully-vested shares and parlayed the money into a nontraded property REIT from Cole. The 6.5% return is unaffected by market swings, making the REIT a unique and steady satellite investment within our total portfolio."

Chief K, meanwhile, favors a REIT mutual fund; he holds  Vanguard REIT Index (VGSLX) within his Roth IRA. He wrote, "REITs aren't currently a 'hot--must own' [asset class] according to the financial press, so it's not overpriced. It's not the highest payer I own, but it's my favorite and did I mention that it's cheap? I get to keep every 99.88 cents of every dollar of earnings."

'The Potential for Capital Appreciation and Distribution Increases'
Income seekers also mentioned several names related to the energy sector. The MLP love fest was in full swing, with rllucky arguing that the securities look more attractive than competing alternatives. "High-quality to medium-quality bonds are trading at or near to par value, and the yields are very low. And the returns on CDs are next to nothing. So you end up making very little, nothing, or losing money to inflation and rising interest rates. But on the other hand, MLPs are investments that have the potential for capital appreciation and distribution increases over time. Although there is a greater risk in losing principal, I feel there is a greater risk [in bonds] if interest rates rise or inflation increases. So I suppose it makes me feel a little better knowing that a business can raise its prices where as the payments on a bond will not increase over time."

Cliff notes that it's impossible to quibble with MLPs' past returns. "I have invested so much in [MLPs] that I simply consider that I'm a partner/owner in a pipeline business, managed by some of the best managers in U.S. business. The total return of the group over the last 15 years has been 16.7%. As for income, the average monthly current yield has been 7.6%." Cliff's favorite pick within the MLP space? 
 Kinder Morgan Management (KMR).

Jerry E, meanwhile, likes a different MLP-- Energy Transfer Equity (ETE)--writing, "I have, like many others, been forced to consider a number of alternative investments to bring in much needed income including MLPs, closed-end funds, REITs, and so on. The very best, without a doubt, has been my investment in Energy Transfer Equity. With those very nice 6%-plus dividends, I am up over 70% over the last three-plus years." 

Lakeside7 favors  Kayne Anderson MLP (KYN), a closed-end fund that employs leverage to plump up its payout. This poster wrote, "It's the largest by far and one of the oldest MLP closed-end funds, with one of the highest distribution rates in the closed-end fund pack, and currently trading at a slight premium that is much lower than usual."

TOOOINTENSE is fond of another CEF focused on the MLP sector,  ClearBridge Energy MLP (CEM), writing, "I bought it at a great discount. It is kind of an energy/natural gas/income/infrastructure investment. I like investments that have more than just a single, focused objective. I like the boat to rise on more than a single tide." 

'Dividend with Room to Grow'
While MLPs and REITs dominated the picks lists for income-oriented investors in stocks, other posters believe they have found good income producers that were hiding in plain sight.

Duanej has been a happy owner of  Coca-Cola (KO) shares. "I started systematically buying dividend stocks in 1995, and subsequently had my eye on Coke for a long time. Finally in 2008 there was a chance to get in at a good price (in my opinion)."

 Altria Group (MO) beckons for HERBSCORE, who likes its "attractive yield, stable dividend with room to grow, smart management team, and strong fundamentals."

For WizardofWeston, the world's most valuable company will be even more attractive once it has a dividend attached to it. "[My favorite income producer] was  AllianceBernstein Holding (AB), but starting in September it will be  Apple (AAPL)."

JerryE has been happy with his big-cap telecom names. "My good old investments in AT&T (T) and  Verizon Communications (VZ) have also paid very handsomely. I am up more than 30% in both of those, counting the dividend income."

Other posters noted that they've looked to mutual funds for a basket of dividend-paying names. Rathgar's pick is  Vanguard Dividend Appreciation ETF (VIG). He wrote, "All of the holdings have had to increase their dividend every year for the past 10 years to make the cut. Low costs, high-quality, inflation-adjusted dividends. I will probably hold this investment forever."

Posters also enthused about funds that hold a mix of dividend-paying equities and bonds. Bigwheel7's picks for example, are  Vanguard Wellington (VWELX) and 
 Vanguard Wellesley Income (VWINX).

 Thornburg Investment Income Builder (TIBIX) also received a few shout-outs. OceanMinded wrote, "I like the strategy, global investing into companies with histories of paying dividends, and showing the capacity to increase them."

 Franklin Income (FKINX) was another favorite. Joan 1234 shared, "I put in approximately $200,000 15 years ago and have taken distributions adding up to approximately $135,000. The balance is only down $6,000 due to market factors. I am very happy with this cash machine which has remained fairly stable and gives me a monthly check."

Other
Other posters were thinking outside the box. FidlStix likes what are called business-development companies--or BDCs--which, like venture-capital firms, invest in small or startup businesses. He wrote, "My single favorite income producer is Prospect Capital (PSEC), a BDC presently paying 11%-plus. In the present low interest-rate environment, I like BDCs in general, since they tend to have simple business models. They borrow at low interest rates, loan out to smaller companies or start-up's, and, like REITS, return 90% of their income to their shareholders. A caveat, however: When interest rates start going up, a BDC's interest margin is likely to plummet, along with the income they have to pass on to shareholders."

Rental property has been a boon to bnorthrop on the income front. "[My favorite income-producing investment] is my single-family rental property. My entry point was low (way before the housing bubble), asset quality is high (Boulder, Colo.), return on investment is roughly 9% (net income), plus about 100% unrealized capital gain."

No matter what your top pick for income production, JerryE offered these words of wisdom. "In all cases, patience is a virtue. Add to your positions on the dips. There has unfortunately been a lot of opportunity to do that." 

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Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.