Investing For Income

Coming on the heels of massive losses over the past 18 months, income investing is back in vogue and probably here to stay for a while.  Most investors have learned the value of patience, at least temporarily, and are extremely keen on being “paid while you wait.”  That is, if you can’t count on 15% capital gains year after year, you can at least rely on steady investment income to tide you over.

To that end, I’ve put together a short list of mutual funds ideally positioned to yield attractive cash returns going forward.  They may not be the top-performing funds in any given year, but if passive income in the form of cash flow from your investments is what you’re in the market for, these funds will deliver.  All of these funds have significantly below-average expense ratios (investment costs matter, after all) and where possible, I’ve stuck to index funds.

You can research all the mutual funds mentioned here for yourself in detail by signing up for a free Morningstar account and entering their ticker symbols into the search box at the top of Morningstar’s site.  I highly advise you to do your own homework before making any investment decision.

All figures are current as of 7/15/2009.

Top Income-Producing Funds

Vanguard Equity Income (VEIPX) – The Vanguard Equity Income fund currently yields 4.36%, which is extremely impressive for an unleveraged, all-equity mutual fund.  Though actively managed, Equity Income sports an expense ratio of only 0.30%, in typical Vanguard style.  Over the last three years, Equity Income has been a bit less volatile than the broad stock market and lost only 31% of its value in 2008.  That may sound like a lot, but remember this is a value-oriented fund and most value funds traditionally invest heavily in the financial sector.  Compared to its peers, this fund performed admirably.  Going forward, this fund should benefit from any economic rebound nicely and pay a handsome income in the meantime.

Vanguard Wellesley Income (VWINX) – The Vanguard Wellesley Income fund is one of the most successful balanced mutual funds of all time.  Founded in 1970, it has to crank out average annualized returns of 9.94% despite an extremely conservative asset allocation consisting of only 40% stocks and 60% bonds and it’s done so with volatility less than half that of the overall market .  It currently yields a healthy 5.13% and costs only 0.25%, which is a bargain for management of this caliber (it’s managed by legendary Wellington Management).  It’s also one of the few funds around with 10-year returns averaging over 5% per year and lost less than 10% of its value in 2008.  Expect steadily-rising payouts and relatively smooth sailing with this one.

Vanguard REIT Index (VGSIX) – This is bound to be a controversial recommendation considering the recent debacle in the real estate market, but real estate has been and always will be an attractive asset class for the income-oriented investor.  The Vanguard REIT Index fund currently yields 6.06% and despite recent troubles, sports a solid 10-year average annual return of 5.31%.  Do I recommend you invest the majority of your portfolio in real estate?  No.  But a 10-20% allocation seems prudent.  Historically, few asset classes will yield as much current income as real estate.

Vanguard High-Yield Tax-Exempt Municipal Bond (VWAHX) – This is the only bond fund on the list because it exhibits an extremely attractive risk-reward profile going forward, which is tough to find among bond funds right now.  It currently yields 5.03%, which is the equivalent of 8.15% for investors in the 35% federal tax bracket, 6.98% for investors in the 28% tax bracket, and 6.7% for investors in the 25% tax bracket.  And the fund didn’t have to take on too much risk to get these yields, either:  its average credit quality is A, which is just below the middle of the investment-grade rating band.  True, the fund will be a bit interest-rate sensitive due to its 7.43 year effective duration, but that’s not something that should concern most income-oriented investors.  After all, we’re after steady income here, not capital gains.

As mentioned before, you can and should research all the mutual funds mentioned here for yourself in detail by signing up for a free Morningstar account and entering their ticker symbols into the search box at the top of Morningstar’s site.  I invite you to do so before making any investment decision.