We see China’s economy as on stronger footing than typically depicted, in both absolute and re...
Is There Anyplace to Invest Your Cash?
03/05/2010 9:31 am EST
For the short term, look to dividends as a safe spot to park your money, but be ready to jump into emerging markets when the time is right.
Maybe you'd love to invest it, but where?
The stock market seems pricey after a 70% rally from the March 2009 lows. And it's been so up and down lately that it doesn't inspire much confidence. So maybe stocks are just too risky for you—perhaps you'll need your money soon for retirement or college tuition. Maybe you'd just like to wait. Or maybe you just need more income than most stocks pay these days.
Bonds are no bargain. A three-month Treasury bill pays only 0.12%. A two-year note pays just 0.79%. Inflation may not be very high, at an annual rate of 2.6% for headline inflation (and 1.6% minus volatile energy and food prices), but it's enough to eat up all the interest from those investments and more.
You could tie your money up for decades and get 4.56% in a 30-year Treasury bond, but 30 years is practically forever. And besides, interest rates have to go up from today's lows, and that means bond prices will come down, probably fast enough to eat up all the interest that Treasury bond pays and more.
Treasury inflation protected securities (TIPS) will protect you from inflation, but the yields are really low—1.43% for ten-year TIPS at recent auction—and they protect you only from inflation, not from rising interest rates, which cause bond prices to fall.
Series I bonds, savings bonds that pay an interest rate that combines a fixed component, currently 0.3%, with an inflation-adjusted variable rate, currently 3.06%, offer a higher yield, but because the variable rate is pegged to inflation and not interest rates, the yield on these bonds won't necessarily go up if interest rates do. You also have to hold them for at least 12 months. (After that and until you've held them for five years, you'll lose the last three months of interest if you sell.)
A certificate of deposit (CD) would make sure you got your invested capital back intact, but the highest rates I could find for a one-year CD were less than 2%. That doesn't even beat headline inflation.
You might as well keep it buried in the backyard—except that would lose out to inflation, too.
Take the Shorter Path up
Here's my advice: Think short term. It's the best way right now to maximize long-term income.
Paradoxical? Not if you realize that interest rates are going up in most of the world— except maybe in Europe and Japan—quite dramatically over the next 12 months. A year from now, or perhaps sooner, you'll be able to get yields well north of anything you can find now.
That pretty much means you're guaranteed to lose money if you lock it up for the long term now.
You'll lose money first because that 30-year Treasury bond, with its 4.5% coupon rate of interest, will look pretty pathetic in a year if 30-year bonds are paying 6%. Investing $10,000 in a bond paying 4.5% throws off $450 in interest in a year. At 6%, all it takes is $7,500 invested in a bond to produce the same $450 in cash. Interested in exploring the misery of watching a "safe" bond lose 25% of its value in a year?
Your portfolio will thank you and your household cash flow will thank you for avoiding as much of this opportunity cost as possible.|pagebreak|
Safety in (Dividend) Numbers
So how do you go about thinking short term in order to maximize long-term income?
For the short term, you need to put your cash into something that's as safe as possible, but offers you as much income as possible and doesn't lock up your money for very long.
My choice is dividend-paying stocks—if they pay a high dividend, are extremely liquid, and are battle tested. Let me use chemical-maker DuPont (NYSE: DD) to show you why.
Here's a stock that's paying a dividend of 4.86%. That's more than you'll get from even a 30-year Treasury at the moment.
The shares are very liquid, so you should have no trouble trading in and out when you need to. Average daily volume is more than seven million shares, and the company has 904 million shares outstanding.
And the dividend has been tested in the Great Recession. The annual dividend was $1.46 a share in 2005, $1.48 in 2006, $1.52 in 2007, $1.64 in 2008, and most impressively, $1.64 in 2009. If DuPont didn't cut its dividend in 2009, I think it's pretty safe unless the economy is hit by another Great Depression.
Dividend stocks such as DuPont also provide another kind of protection. If interest rates rise faster than anyone now expects, it will (short of a meltdown in US finances, which is unlikely in the short term) be the result of faster-than-expected economic growth triggering faster-than-now-anticipated interest rate increases from the Federal Reserve.
If that happens, a company like DuPont will see its revenue and earnings go up faster than is now anticipated. That should more than make up for any downward pressure on the stock price when the dividend no longer seems quite so juicy. (For what to worry about in 2010, see this February 15 column.)
That's exactly what happened in 2009 as the stock market began to anticipate an economic recovery. The yield dropped from 6.48% at the end of 2008 to 4.87% at the end of 2009. But the stock's price soared 40%.
Of course, if the opposite happens and the economy tanks again, the stock price will go down for the duration of the slump, but you will still be collecting your fat dividend.
NEXT: Where to Find the Best Yields Now|pagebreak|
Where the Best Yields Are
OK, now let's look at where you might be able to find the highest yields in the long run. My bet here is on the world's emerging markets.
The odds are that countries such as Brazil, India, Turkey, and even Mexico are much closer to the beginning of a series of interest rate increases than any of the developed economies are. Economic growth in these countries is already so strong that central banks are seriously worried about inflation. It's not a question of when they start raising interest rates, but how quickly they do—and for how long.
For example, the forward/futures market is pricing in an increase in interest rates in Brazil to 11.5% by the end of the year. That would be a 2.56-point increase.
The futures markets are pricing in increases of 1.86 percentage points, to 9.05%, in Turkey, and 1.19 percentage points, to 4.66%, in India.
Higher interest rates, if they work the way central banks would like them to, would slow these economies. But growth should still be stronger than in the European Union, Japan, or the US, and that should keep stock markets in these countries rising. Higher interest rates would push local currencies such as the Brazilian real higher against the euro and the dollar, and that would offer additional profits and protection to European and US investors.
You can execute this long-term strategy by buying stocks in emerging markets, as long as you stick to utility and utility-like stocks. Companies that need to raise capital frequently try to keep their dividend yields in line with interest rates so they can compete with bonds to raise capital. Three to consider are Telkom Indonesia (NYSE: TLK), a stock in my dividend income portfolio, Philippine Long Distance Telephone (NYSE: PHI), and Turkcell Iletisim (NYSE: TKC). The latter two are on Jim's Watch List.
I'd say buying emerging market bonds would be an even better strategy toward the end of the year—if you can find an exchange traded fund or closed end, emerging market bond fund that, ideally, buys bonds denominated in local currencies and focuses on the right mix of markets.
That's because buying emerging market debt directly can be just too hard and expensive for individual investors. I'm going to test exactly how difficult it is for individual investors to buy the bonds of big emerging market companies that issue lots of debt, such as AmBev (NYSE: ABV) and Vale (NYSE: VALE) of Brazil, and Cemex (NYSE: CX) of Mexico. I'll report back on what I find here.
In the meantime, although I haven't found any that exactly match what I'm looking for, I'd certainly take a look at the closed-end funds AllianceBernstein Global High Income Fund (NYSE: AWF) and Morgan Stanley Emerging Markets Debt (MSD), and, among mutual funds, MFS Emerging Markets Debt (MEDAX) and Fidelity New Markets Income (FNMIX). Among ETFs, take a look at iShares JPMorgan USD Emerging Markets Bond (EMB).
You want to buy closed-end funds when their prices are below their list net asset values. Unlike normal mutual funds, which are priced based on the securities they own, closed-end funds' values can deviate from their underlying assets because of investor sentiment.
You've got time to research these choices. Don't buy them until emerging market interest rates have moved up some.
At the time of publication, Jim Jubak owned shares of the following companies mentioned in this column: AmBev, Telkom Indonesia and Vale.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.
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