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Diversification Lets You Increase Portfolio Yield without More Risk

Sure, you make the bulk of your investments in money market funds to minimize risk. But what are you getting in return? You can boost your portfolio’s yield safely with a dollop of REITs and floating-rate funds, in addition to some tax savvy.
Thomas Walsh
PUBLISHED: Monday, May 15, 2017
Money market funds are low-risk but pay little. Junk bonds and long-term bonds yield more but they’re risky. So how can you ramp up yield without taking on too much risk?
 
With strategic diversification, you can safely boost your portfolio’s yield. It’s the only strategy that can both decrease risk and increase yield. True diversification is about building a portfolio of uncorrelated investments that aren’t all affected by the same economic factors.
 
Some risks aren’t worth taking. Long-term rates are very low. If they rise significantly, you can lose a lot of money in a long-term bond fund. In the current environment, the higher yield is typically not worth the increase in risk.
 
Where can you get more yield without too much risk? Consider REITs and floating-rate funds.
 
REITS BOOST YIELD AND DIVERSIFICATION
Due to real estate’s low correlation with other investments, REIT funds can provide a hedge against a lengthy period of poor performance in the stock and bond markets. The investment’s low correlation to other assets may provide an opportunity to reduce risk and increase portfolio yield.
 
A diversified REIT fund produces reliable income from properties such as shopping malls, apartment buildings, office buildings and hotels. Since these properties are generally located across the U.S., and sometimes in other countries, geographic risk is minimized.
 
But don’t go overboard. While REIT funds offer good yields, like all other equities, they’re volatile. So limit your REIT investments to 7.5 percent of your equity allocation. Even that modest allocation offers yield and diversification.
 
I recommend actively managed and index REIT funds that invest in the U.S and abroad. Avoid private and obscure REITS to keep risk down.
 
FLOATING-RATE FUNDS OFFER BULWARK AGAINST RISING RATES
Floating rate or bank-loan funds buy loans made by banks to companies with below-investment-grade credit ratings. Their higher yields and floating rate make them attractive.
 
Because the underlying loans’ yields can rise along with broader market rates, share prices may hold steady when rates rise, thus protecting you from interest-rate risk.
 
Unlike other high-yield bonds, floating-rate loans have safeguards built in, including collateral requirements, performance-based covenants and a senior position within a company’s capital structure. Senior debt is more likely than other debt to be repaid in case of bankruptcy. Many loans have floor provisions so that interest payments cannot go lower than a set minimum should market rates decline.
 
These funds are attractive when rising interest rates are a greater concern than the creditworthiness of the underlying investments.
 
A skilled fund manager controls risk by choosing more-secure loans. Look for a conservatively managed floating-rate fund instead of trying to find the highest yield.
 
You can safely invest up to 15 percent of your fixed-income portfolio in a floating-rate fund.
 
STASH HIGH-YIELDERS IN RETIREMENT ACCOUNTS
Investments that produce large amounts of ordinary income, such as floating-rate funds and REITS, should usually be held in tax-deferred accounts like IRAs and 401(k)s. The tax bite on your portfolio is reduced, allowing for greater long-term growth and higher total returns.
 
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