Alternatives To Bond Funds

7/16/2012


For many investors, holding bonds makes sense. But with high-quality bonds yielding so little today, even conservative income investors should give stocks a look.

The benchmark Barclays Aggregate Bond Index yields only 1.9%, while the average taxable intermediate-term bond fund pays roughly 2.6% — in line with the average dividend-paying stock in the S&P 500 Index.

While stocks are more volatile than bonds, they tend to outperform over the long haul. Since 1926, large-cap stocks have delivered an annualized return (including dividends) of nearly 10%, versus less than 6% for intermediate-term government bonds.

Bonds have outperformed over the last 10 years and continue to receive the bulk of mutual-fund inflows, but recent returns could help stock funds win back some fans. Since the start of 2012, the average large-cap blend fund is up 6.2%, versus 4.3% for intermediate-term bond funds. Over the last three years, large-cap blend funds returned an annualized 15.3%, compared to 8.2% for intermediate-term bond funds.

In addition, dividend-paying stocks tend to deliver less-volatile returns than the average stock. U.S. stock funds with recent yields of at least 2% averaged a three-year annualized standard deviation (a measure of volatility) of 16%. In contrast, funds yielding less than 2% averaged a standard deviation of 19%.

The table below lists 10 attractive income funds from nine different categories, all of which hold more in equities than in bonds. To make the cut, a fund needed to yield more than the average dividend-payer in the S&P 500 and the average intermediate-term bond fund.

10 TOP FUNDS FOR INCOME
Trailing
12-Mo.
Dividend
Yield
(%)
--- Total Return ---
Fund (Price; Ticker)
YTD
(%)
3 Yrs.
(Ann.)
(%)
Expense
Ratio
(%)
Category
Mutual funds
American Century Equity
($5; ACIVX)
3.8
7.7
17.2
0.49
Large-cap blend
Fidelity Telecom and Utilities
($18; FIUIX)
2.8
6.8
18.8
0.71
Utilities
Vanguard High Div. Yield
($22; VHDYX)
2.8
6.9
19.8
0.25
Large-cap value
Vanguard REIT ($19; VGSIX)
3.2
15.0
36.8
0.24
Real estate
Vanguard Wellington
($33; VWELX)
2.9
5.5
13.2
0.27
Balanced
Exchange-traded funds
ALPS Alerian MLP ($16; AMLP)
6.3
0.1
NA
0.85
Ltd. partnerships
iShares Dow Jones Select Div.
($56; DVY)
3.5
6.3
22.5
0.40
Midcap value
iShares S&P U.S. Preferred
($39; PFF)
5.9
12.8
14.8
0.48
Preferred stock
SPDR S&P Dividend ($55; SDY)
3.2
3.8
18.5
0.35
Large-cap value
WisdomTree SmallCap Div.
($49; DES)
3.4
10.4
24.3
0.38
Small-cap value

iShares S&P U.S. Preferred Stock Index ($39; PFF), with a current yield of 6.5%, has returned 12.8% so far in 2012. Preferred stocks often behave more like bonds than stocks because they are sensitive to an issuer's creditworthiness. The fund, with an expense ratio of 0.48%, has a three-year annualized return of 14.8%. 


Vanguard Wellington ($33; VWELX) is a longtime Forecasts favorite and a holding in our recommended Growth and Conservative portfolios. The fund, which holds roughly 60% stocks and 40% bonds, yields 2.6%. Its 10-year annualized return of 7.3% ranks among the top 6% of its peer group. The expense ratio is 0.27%.

OUR RECOMMENDED MUTUAL FUNDS
Through July 10, our recommended Growth Portfolio has gained 6.2% so far this year, versus a 6.0% gain for its benchmark portfolio. The Conservative Portfolio is up 6.0%, versus 4.9% for its benchmark.
-- Year-To-Date --
--- % Of Portfolio ---
 
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
Dreyfus Midcap Index ($28; PESPX)
6.7
B
0
0
90
Dreyfus Small Cap Stock Index
($21; DISSX)
7.3
B
0
0
91
Fidelity High Income ($9; SPHIX)
7.9
B
5
5
86
Homestead Small Company
($25; HSCSX)
8.1
A
7
8
98
Manning & Napier International
($8; EXITX)
(1.2)
E
7
7
57
T. Rowe Price New Horizons
($34; PRNHX)
11.1
A
10
10
100
Vanguard 500 Index ($124; VFINX)
7.8
B
6
7
81
Vanguard Dividend Growth
($16; VDIGX)
5.1
D
12
12
98
Vanguard Emerg. Mkts. Stock Indx.
($25; VEIEX)
2.9
C
0
4
70
Vanguard GNMA ($11; VFIIX)
1.8
D
5
4
90
Vanguard Growth Index
($35; VIGRX)
9.4
B
12
12
96
Vanguard Inter.-Term Tax-Exempt
($14; VWITX)
3.3
B
0
0
67
Vanguard Selected Value ($19; VASVX)
4.7
C
5
6
83
Vanguard Short-Term Invest.-Grade
($11; VFSTX)
2.5
B
0
0
92
Vanguard Total Bond Mkt. Index
($11; VBMFX)
3.1
D
9
0
56
Vanguard Total Int'l Stock Index
($13; VGTSX)
1.9
C
5
4
69
Vanguard Wellesley Income
($24; VWINX)
5.5
B
0
0
100
Vanguard Wellington ($33; VWELX)
5.5
B
6
9
89
Wasatch International Growth
($20; WAIGX)
13.2
A
5
5
94
Wells Fargo Advantage Discovery
($25; STDIX)
9.0
A
6
7
89
* Year-to-date ranks through July 10 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%;
E = bottom 20%. Fund ratings are percentile ranks based on our fund-rating system.

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