If you have any cash sitting in an account collecting interest, you’re well aware of the dismal rate of return that you’re earning. Don’t blame the banks though – they must invest in fairly low risk securities to keep your money safe. If they are not earning much, they will not pay you much.
Income investors are always looking for a great place to park their money. Whether you’re a young, conservative investor or a retiree that needs to collect a monthly income, a high interest rate is what you desire. The issue we face today is an environment where rates are barely over 0% on products such as money markets and CDs.
Where do you invest your money then? I will list 8 investment strategies/products that will generate a return that you can actually live of off. Of course, associated with a higher return is a greater investment risk. I will start with the most conservative of the investments, increasing the risk as we progress.
Municipal Bonds | return ~ 4.5% + tax advantage
Municipal bonds are issued by a municipality such as a state, city or county and fall into one of two categories – general obligation or revenue. Obligation bonds have a lower degree of risk because the municipality has the obligation to pay. This type of bond is common for funding sewage upgrades, transportation improvements or even park maintenance. Basically, you are lending the municipality money to fund an infrastructure improvement project.
Revenue bonds on the other hand, contain slightly more risk because payment of the coupon is dependant of the project that was funded. This could consist of the construction of an amphitheater, stadium, performing arts center, etc.
The beauty of both types of municipal bonds is that they generally contain tax benefits for the holder at the federal, state and local level. This tax advantage must be factored in when considering what the tax-equivalent yield would be. Check out my calculator to discover what that exact yield is.
Corporate Bonds | return ~ 4 – 6%
The concept of corporate bonds is the same as municipal bonds except that you are letting a company borrow your money instead of a municipality. Also, corporate bonds are fully taxable so you do not receive the tax benefits. Because of this, the rates must be higher to make the bonds more attractive.
Preferred Stock | return ~ 4 – 8%
Many investors do not take advantage of preferred stocks because they don’t fully understand what they are. Simply put, they are a combination of common stock and bonds. They contain both properties of a debt instrument in that they pay a coupon payment and have a par value of $25 (bonds have a par of $1000). Also, the preferred security will fluctuate up or down as the company’s common stock moves.
High-yield Exchange Traded Funds | return ~ 7%
The corporate bond rate that I referenced in example number two was that of investment grade bonds. There are companies with decent to bad credit that must pay a higher interest rate to borrow money. While I wouldn’t invest in any of these directly, you can take advantage of their generous rates by buying into a high-yield ETF. The ETF will contain a basket of securities, some of which are high-yield, junk status bonds. Some of these bonds may default, but because you have a basket of these funds, only a small amount will be lost.
Peer-to-Peer Lending | return ~ 8 – 11%
This is a pretty new investment opportunity that has many people very excited – both borrows and lenders. Two companies, Prosper and Lending Club, allow individuals to be lenders or borrowers. In this case, I’m of course referring to the lending side as we want to earn income, not pay interest.
You are able to deposit your own capital and choose who you would like to lend it to. The people or small businesses that are trying to borrow money are lumped into categories depending on their credit rating. The higher the credit score, the more likely the person is to pay back the money borrowed, so the interest you receive will be lower than if the person has fair credit. Neither site allows people with credit scores below 640 to participate on the borrowing side.
Money can be loaned in increments of as little as $25, exposing you to little risk per loan. Of course, people will default, failing to pay for their obligations, but these defaults are offset by the phenomenal rate you receive from the ones that pay.
Covered Call Funds | return ~ 8 – 10%
Covered call funds are mutual funds or ETFs that actively manage a covered call portfolio. Within the portfolio, the fund manager will purchase stock/ETFs and sell calls against those positions. This strategy has less risk than selling covered calls on your own because the fund is actively managed and spread out for you.
Dividend Paying Stocks + Covered Calls | return ~ 8 – 12%
Many blue-chip stocks are paying modest dividend yields today. You can easily receive 2 – 4% from the dividend alone. However, I would take it a step further and sell covered calls against the stock position that you own. As long as the stock is not called away from you, you will received the dividend and have the opportunity to sell more calls when the current ones expire. This strategy is no different than selling covered calls on any other asset, so the risk is the same.
Real Estate in an IRA | return ~ varies too much
This is another fairly new investment tactic that is becoming more popular. You could go out and buy real estate at a very affordable rate today, but you need to either borrow from the bank or put up capital of your own. An alternative is to buy a rental home with the money in your IRA. The assets are not distributed from the IRA so there are no tax implications. Each time a tenant pays rent, that rent is deposited into the retirement account and can be used to invest in securities or hold in cash. Not only do you reap the benefits of monthly payments, but the real estate should appreciate in value as well.
As I said in the beginning, coupled with higher returns is greater risk. Because all of these strategies pay more than CDs or Treasuries, they are inherently more risky. Please make sure you understand that risk ahead of time. I will be discussing each strategy independently and at that time, I will detail the complete risks associated with each one.
READERS: Do you have any other income generating strategies that you’d like to share (annuities, REITs, etc.)? Have you had success with any that I’ve mentioned? Do you think my risk ranking was accurate?
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