There are no truly “safe” investments and likewise no truly “safe” tax-free high yield investments. Every investment has risk, and it’s important that you understand every type of risk associated with a given investment. That being said, some investments carry less risk than others.
There are certain ways you can fight and claw your way to a 5% tax-free yield on certain investments. They won’t be completely without risk, but the risks will be limited. Let’s take a look at a few possibilities for this tax-free high yield investments.
A Look at Winning Funds
Nuveen AMT-Free Quality Muni Income Fund (NYSE:NEA) is the first thing to look at for tax-free high yield investments. The distribution rate is 5.37% and it’s generated off of mostly longer-term muni bonds that are from municipalities all over the country. The expense ratio is 0.94%, although there is a 100 basis point interest expense addition for those who find that statistic important.
You’ve got a couple of challenging trade-offs however. Almost 70% of the fund has bonds that are rated “A” or higher. However the longer-term nature of these bonds is such that there is interest rate risk to be concerned about. That may be one of the reasons the fund trades at a 12% discount to NAV. We are in a rising interest rate environment.
That means as rates increase bond prices decrease. So you may earn that delicious tax-free yield, but be aware that you may experience capital losses in the interim. This is a fund best held her a long time.
BlackRock MuniYield Investment Fund (NYSE:MYF) is another closed-end fund that invests in different forms of municipal bonds and offers tax-free high yield investments. The fund yields a little bit more than 6% per year.
I like this one a little bit better because it is not as heavily weighted towards longer bond maturities. For example, 26% of the fund is weighted towards 1-3 year bond maturities and 13% towards 10-15 year maturities.
While I am not in love with the 27% weighting towards New York municipalities, given the lousy financial state of New York, I also don’t see it as having enough risk to torpedo the whole fund.
The three year average annual return to the fund is 2.7%, but has a standard deviation of 3.8, meaning there is a 95% chance that in any given year the fund will return between -4.8% and + 10.2%. Be advised, however, that we are again dealing with a muni bond fund in a rising rate environment.
Ashford Hospitality Trust 8.45% Cumulative Preferred Series D (NYSE:AHT-PD) is a preferred stock of a very successful hotel real estate investment trust. The D series has been in existence for many years, and is actually well past its call date.
However, the company has not seen fit to redeem the shares and they do trade slightly above par. That means should the company choose to redeem the shares at par, there will be a slight capital loss. However, I don’t see that as being very likely. For now the shares are one of a series of great tax-free high yield investments, yielding 8.45%.
The Bottom Line on Tax-Free High Yield Investments
There are two ways to think about achieving a 5% tax-free yield. First of all, if you aren’t a very high tax bracket your net yield is very likely to come in about 5%. However, in almost every case when it comes to preferred stock, the money that you receive is a dividend is almost always classified as “return of capital.”
That is to say, the money is not taxable. It is considered a return of your initial investment. Yes, I know, that sounds a little strange. Even though the full amount of money that you invested is still sitting there in the preferred series of stock that you own, the distribution is almost always classified as return of capital.
Note that I say “almost always.” You shouldn’t rely on this fact, but it’s been the case for me when it comes to preferred stock in almost every situation.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at [email protected].