10 picks for income investors

By Jim Jubak

Just look at these yields! Shares of Genco Shipping (GNK, news, msgs) are paying 53.3%. Diana Shipping (DSX, news, msgs) 47%. Monarch Coach (MNC, news, msgs) 33.3%. Wow!! Snap, 'em up, right?

Wrong. Now is no time to get giddy about yields. A Wall Street saw, "Pigs get fed, but hogs get slaughtered," is especially appropriate for income investors right now.

But I do have 10 picks in this column with juicy yields and solid fundamentals. There are no 50% yields in the bunch but no risky industries struggling to survive either. These 10 picks are based on three solid strategies for maximizing income in a retirement portfolio and for making money in the rally that will one day follow today's bear market.

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In a recession, especially in a deep, long recession like we're in now, companies in trouble wind up cutting dividends to preserve cash and fend off creditors. So huge 50% dividend yields aren't a sign screaming "bargain" but a result of plunging stock prices and of danger ahead.

Genco and Diana, for example, are both dry-bulk shippers. The business of sending cargoes of coal and other bulk goods around the world has collapsed with the slowdown in the global economy. Charter rates for the largest dry-bulk carriers have plunged to $2,773 a day, as of the end of November, from an all-time high of $233,988 a day on June 5. No wonder that Diana suspended its dividend in early November and that Star Bulk Carriers (SBLK, news, msgs) will pay its third-quarter dividend half in cash and half in shares.

Monarch Coach is in a different industry, recreational vehicles, but it's been hit just as hard by the recession, and only loans arranged at the last minute have kept the company afloat. Shares that had sold for $10 in April traded at 72 cents as of Dec. 5.

But it's also no time to write off all high yields. The financial crisis has pushed the prices of shares and bonds issued by many thoroughly sound companies to unprecedented lows. You won't get a yield of 50% from stocks and bonds like these, but you can pick up yields of 7%, 10% or 12% without the risk that the company is about to stop paying a dividend or go out of business. For example, the G series preferred stock of JPMorgan Chase (JPM, news, msgs) was paying a dividend yield of 7.6% on Dec. 5, for a bank that's likely to emerge from this financial crisis as the strongest U.S. bank.

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Where to look for high yields

Investment-grade company bonds, in general, are paying the highest spreads on record above the yield on Treasury notes and bonds, according to Ryan Labs, a New York asset management company. Corporate bonds rated AA by Standard & Poor's are paying 4 percentage points more than Treasury bonds, Ryan Labs calculates.

These huge spreads over the yields on Treasurys have been created by two factors:

• Mass selling of corporate stocks and bonds by investors running away from risk has pushed up yields on corporate securities. (When the price of a dividend-paying stock or bond goes down, the yield goes up.)

• Mass buying of Treasury bills, notes and bonds by investors running toward safety has pushed down those yields. Treasury issues pay almost nothing right now because investors are so desperate to find safety. On Dec. 4, three-month T-bills paid a yield of just 0.02%. Two-year T-bills yielded just 0.84%, and 10-year notes were yielding just 2.57%.

So how do you play this extraordinary market to get the best return without taking on too much risk?

3 tacks investors can take

I've got three strategies to suggest, depending on how far off in the future your goal is and on how much extra short-term risk you're willing to take on. (You can implement these strategies with either stocks or bonds, but since whatever expertise I have is on the equity side of the financial market, I'm going to stick to stocks in my recommendations.)

Strategy No. 1: When the market gives you lemons, make lemonade. I've been talking about this strategy at The Money Show and in front of investment clubs for the past few months. This truly terrible market for stocks is a glorious, once-in-a-decade opportunity to lock in a 10% cash flow for retirement. If you lock up cash flow like this, it will reduce your need to sell stocks and bonds in retirement.

For example, let's say you need a $50,000 annual income in retirement, and you anticipate the market will be only mediocre, with just a 6% return during the years of your retirement. If you have a $300,000 retirement portfolio appreciating at 6% a year, you'll have $318,000 after one year -- minus the $50,000 you need to live on. That's actually a balance of $268,000 after one year. At that rate, you will deplete your savings at the end of Year 8.

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But let's say that you manage to put $100,000 of that portfolio into stocks or bonds that are now yielding 10%. That gives you a steady cash flow of $10,000 a year every year in retirement, before you sell anything. In that scenario you don't run through your retirement savings after eight years but after 10 years instead. You don't have to show up on your kid's doorstep with your belongings in a cardboard box until Year 11. That's two more years of financial independence from harvesting the lemons produced by this market.

This scenario will be especially attractive to investors who are pessimistic about future market returns. If you think we're in a long-term, secular bear market, with likely returns well below my 6% example, this strategy is for you. If you think we're going to bounce back from this bear and move directly into another decade-long bull market, you won't want to pursue this strategy. (It's a good insurance policy in case you're optimism is misplaced, however.)

What do you want to buy with this strategy? Stocks with current yields at 10% or higher where the dividend payout is sustainable at current levels for a decade or more. If the stock market recovers, of course, the dividend yield will drop, but you don't care. All you want to know is that if you buy $10,000 in annual cash flow now, you'll get at least $10,000 of annual cash flow in retirement.