Municipal bonds––debt backed by cities, states, and other local governments––have also had a great run lately, with the S&P Municipal Bond Index returning 5.8 percent in the past year. Muni bonds can be tax-free, and that’s made them popular after recent tax increases on wealthy Americans, says Marilyn Cohen, president and chief executive officer of Envision Capital Management.
While Cohen thinks munis will keep doing well, she says investors need to diversify, spreading their exposure over bonds with shorter durations.
Unfortunately, investors are drawn to the riskiest bonds because they also offer the biggest payouts. The riskiest muni bonds, for example, are issued by governments with fiscal trouble, including Chicago, Puerto Rico, and New Jersey, Cohen says. “You can tiptoe around those land mines.”
High-yielding stocks, which Hsu calls “junk stocks,” have the same risks. Dividend payouts at troubled companies may look generous, but there’s a good chance those companies won’t be able to keep paying them. “You’re picking up a lot of risk,” Hsu says.
Income investors may not be able to avoid risk entirely. With stocks at record highs and interest rates at record lows, it’s harder and harder to find an income that’s perfectly safe. To get the income they need, investors need to protect themselves by spreading their assets among as many income-producing investments as possible. And they should beware of any investment that promises a big payout––it’s almost certainly too good to be true.