Increasing Returns in a Low Rate Environment

While low interest rates tend to be good news if you carry consumer debt or if you're shopping for a mortgage, they're not such great news if you're a fixed-income investor seeking a steady stream of income to meet your living expenses during retirement.

The Federal Reserve has lately been following a policy of keeping interest rates low. With the strength of the economic recovery still uncertain, the Fed hopes that continued low interest rates will help stimulate economic growth.

While low interest rates tend to be good news if you carry consumer debt or if you’re shopping for a mortgage, they’re not such great news if you’re a fixed-income investor seeking a steady stream of income to meet your living expenses during retirement.

Investment Tradeoffs

When interest rates go down, the yields (or returns) and available rates on fixed-income investments usually also go down. These include investments like certificates of deposit (CDs) and bonds. “Many retirees prefer to invest the bulk of their portfolio in these kinds of fixed-income investments because one of their main goals is to provide income,” says David Lerner, president of David Lerner Associates.

But when it comes to investing, there are always tradeoffs. To potentially obtain a higher yield on investments, you will likely have to move further out on the risk spectrum into investments like stocks and high-yield (often called “junk”) bonds.

A Few Options

So what are your options if you want to increase your investment returns in the current low-interest rate environment without giving up too much liquidity or taking on too much risk? Here are a few ideas:

• Municipal bonds— a municipal bond is a pledge by an issuer (usually a public body or agency such as a state, city or county government or a governmental agency) to pay a fixed sum of money on a future date at a fixed rate of interest.

“Municipal bonds offer unique tax advantages that make them an attractive investment option for many retirees,” Lerner explains.

Specifically, if an investor purchases tax-free bonds issued from his or her home state or from a commonwealth or territory of the US, the interest is usually triple-tax-free. For example, if a New York City resident purchases any type of New York tax-free bond, the income is normally exempt from Federal, New York State and New York City income taxes.*

This tax-free status can increase the effective yield on the investment. For example, the effective yield of a New York City municipal bond yielding 4.5% purchased by a New York City resident in the 43% marginal tax bracket would be 7.89%.

Potential investors need to understand that the market value of bonds does vary. It is generally a function of interest rates and credit risk. If interest rates rise, the prices of bonds usually decline. Changes in a credit rating or credit outlook on a bond can also have a positive or negative impact on its price.

• Real Estate Investment Trusts (or REITs)— REITs allow you to participate in the ownership of income-producing real estate, including regional malls, apartments, office buildings, shopping centers and hotels.

Certain REITs seek to provide reliable income distributions to investors and may offer tax advantages as well, which may make them a good option for investors seeking an  income stream during retirement. This income stream is not guaranteed and may vary along with the performance of the real estate.

• Mutual funds— a mutual fund is a collection of stocks, bonds or other types of investments. Mutual funds help reduce the risk of purchasing a single investment by spreading your money out among many different stocks, bonds or other investments.

Mutual funds that invest in bonds, REITs and other dividend-producing instruments may be good options to try to increase your yield and income stream. Certain municipal bond funds seek to provide investors with high current income that is exempt from federal tax, including the Alternative Minimum Tax. Dividend income can be received monthly or automatically reinvested back into the mutual fund.

A wide variety of different types of mutual funds is available, depending on your risk tolerance and desired yield. The more risk you’re willing to assume, the higher your potential yield might be, but also the greater your potential for loss. Conversely, you may assume less risk with a lower-yield mutual fund, but you may also sacrifice some potential for higher returns.


*Certain tax-free municipal bonds may be subject to the Alternative Minimum Tax. Investors should consult with their tax preparer or tax advisor to determine if they are subject to AMT.