Here Are 3 Ways to Get Better Yields Than Bonds, With Some Measure of Safety
Despite the recent surge in bond yields, some alternative investments provide much better yields with varying degrees of safety.
They include Treasury savings bonds, multi-year guaranteed annuities from insurers, and—for investors willing to take on more risk—interval funds that invest in credit instruments.
The purpose of bonds is to balance the stocks in your portfolio. That’s the reason we’re not including dividend-paying stocks, which tend to plunge when your stocks are heading south, providing no ballast at all.
By contrast, savings bonds and most multi-year guaranteed annuities should ride out a recession with hardly a ripple. Interval funds will get hit when the economy contracts, but still tend to be less volatile than stocks.
Here are three higher-yielding investments to think about instead of bonds:
Treasury Series I Savings Bonds. For the truly risk-averse, these bonds are government-guaranteed and as safe as they come. They currently pay 7.12% because their rates are tied to inflation. The rate is adjusted every six months—in May and November—and probably won’t persist, but they are still a great investment currently.
Indeed, the biggest problem with I bonds is that the government limits you to $10,000 per year. You can buy them electronically at Treasury Direct.
I bonds come with restrictions. You can’t touch your money for a year after you buy one. For the first five years, you will pay a penalty of three month’s interest for tapping your money. After that there are no penalties.
The current interest rates make them a bargain even if you have to access the money before the five years are up.
“Even if you lose three months’ interest, you’re still doing better than with other investments,” says Michael Finke, a professor of wealth management at the American College of Financial Services.
The interest you receive from I bonds is subject to federal tax but not to state and local taxes, making them doubly attractive in high-tax locations like New York City or California.
Multi-Year Guaranteed Annuities.These are the equivalents of bank certificates of deposits, except that they’re sold by insurers. As of Friday morning, you could get a a 5-year MYGA from an A-rated insurer yielding as much as 3.15%. By contrast, a 5-year Treasury yielded 2.532% and most bank CDs pay far than that. A similar 3-year MYGA yields up to 2.65%, but has become less of bargain in recent weeks as the yield on a 3-year Treasury shot up to 2.501%.
MYGAs aren’t backed by the U.S. government like a bank CD. However, they are backed by state insurance guaranty funds. Even if the insurer that sold you the MYGA goes broke, which is a rare event, you will get your principal back though you may get reduced interest. “As long as you’re within the state guarantee limit, there is basically no credit risk,” says Larry Swedroe, chief research officer at Buckingham Strategic Wealth.
Different states have different limits and can be found on the National Organization of Life and Health Insurance Guaranty Associations’ website.
If you want to invest more than the state limit where you live, you can buy MYGAs from more than one carrier to stay within the limit, says insurance agent Stan Haithcock, who calls himself “Stan the Annuity Man.” His website gives MYGA quotes all over the country plus the credit ratings of the insurer offering them. Despite the state guarantees, to spare yourself grief, you want to buy MYGAs from financially strong insurers.
You may be able to get even higher interest rates by buying longer-duration MYGAs. But many financial experts counsel against it. If rates keep rising, you’ll be locked into a lower rate.
MYGAs come with a potential tax benefit. You don’t have to pay taxes on the interest they pay until you take the money out, meaning you can roll them over tax-free. Say you buy a MYGA at age 63 when you’re still working and in a high tax bracket. You can wait until you’re retired and in a lower bracket to take the money out.
Unlike Treasuries, MYGAs aren’t liquid. There are often substantial surrender penalties, sometimes 8% or 9%, if you want all your money before they mature, Haithcock says. “Some of the surrender fees are predatory,” he says.
Interval Funds. For those willing to own riskier assets, consider interval funds that invest in credit instruments. Many are paying 7% to 10% yields—equity-like returns with less volatility than stocks.
They are called interval funds because they invest in illiquid assets and you can access your money only on a quarterly basis. And even then funds generally are required to repurchase not less than 5% of their shares each quarter. That means if a bunch of investors want their money at the same time, they may get only part back and have to wait for the rest.
Different interval funds are targeting different corners of the credit market. The $6.2 billion Cliffwater Corporate Lending Fund (ticker: CCLFX) yielded 7.3% at year-end. It invests in private loans made to middle-market companies. The fund is sold only through investment advisors and other institutions.
It’s only 2½ years old. It lost 2.15% in March 2020 during the early days of the pandemic, says Brian Rhone, a Cliffwater managing director. It didn’t exist during the 2007-09 recession, but Cliffwater has constructed an index of similar loans and it calculates it would have lost 6.5% in 2008 and risen 13.2% in 2009. That’s a decent amount of volatility, but much less than stocks. The S&P 500 stock index returned a negative 37% in 2008, and posted a 26.5% return in 2009.
Other interval funds are pursuing higher-risk strategies and won’t provide the same portfolio stability as bonds. The $2.9 billion Pimco Flexible Credit Income Fund (PFLEX) can buy any sort of debt, including residential loans and emerging-market debt. In terms of risk, “I would say it fits between bonds and equity,” says Christian Clayton, a Pimco executive vice president.
The fund has averaged a 6.3% return since its inception in 2017. But that included a roughly 20% decline in March 2020 as the pandemic shriveled the economy.
But because of the interval fund structure, investors weren’t able to access their money until May 2020, when the fund had recovered nearly half its losses. “In March the fund was able to go on the offense and purchase assets at depressed prices since investors couldn’t redeem,” Clayton says.
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