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How to Build an Income Portfolio Now

By Daren Fonda
Kiplinger’s Personal Finance

If you own a mix of stocks and bonds, you may expect the stocks to cause you periodic bouts of anxiety. But it’s bonds that have been acting up lately, and in coming years they may not live up to their reputation as a portfolio sedative.

After benefiting from declining interest rates for decades, bond investors are now bracing for rates to rise over the next few years as the economy heats up. That prospect has sent bond yields soaring and pushed down prices (which move in the opposite direction). From July 8, 2016, through the end of the year, the yield of the benchmark 10-year Treasury note rose from less than 1.4 percent to 2.5 percent – a stunning jump.

Rising yields aren’t all bad; you’ll pocket more income as rates increase. But you could lose money along the way. Buying a 30-year Treasury bond, for example, would get you a yield of 3.1 percent. But if market rates were to increase by one percentage point, the bond’s price would likely fall by nearly 20 percent, wiping out more than six years’ worth of interest income.

So how do you invest for income in this climate? Start by playing it safe, says Scott Schwartz, a money manager with Bleakley Financial Group, in Fairfield, N.J. Because long-term bonds look risky now, Schwartz recommends swapping them for bonds with shorter maturities, which should hold their value better if rates continue to rise.

Even with rates increasing in recent months, high-grade short-term bonds don’t pay much. But you can supplement your income in other ways. For instance, the average floating-rate bank loan yields 4.7 percent and would benefit from higher short-term rates, which bump up the loans’ payouts. Junk bonds, although risky from a credit-quality perspective, should fare relatively well if rates keep climbing. They yield an average of 6.1 percent.

The stock market offers some appealing income plays, too. Energy-related master limited partnerships, which own pipelines, storage facilities and processing plants, are getting a lift from strengthening oil prices; these MLPs yield a healthy 7.1 percent, on average. Property-owning real estate investment trusts yield an average of 4 percent. Rising rates have pressured REITs, but property owners can lift their income through acquisitions and rent increases. That should help boost REITs’ earnings – allowing them to raise dividends -- and help to support the stocks.

Of course, the more yield you strive for, the more risk you take. “Being patient and diversified is so important in this market,” says Amy Magnotta, a money manager with Brinker Capital, in Berwyn, Pa. “You don’t want to reach purely for yield.”

Editor’s Note: Daren Fonda is an associate editor at Kiplinger’s Personal Finance magazine,

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