Congratulations, savers. Your money-market fund is now yielding more than inflation, if only by a hair. But after paying taxes on your money fund's earnings, you're still behind the inflation bogey.
What to do? "Nothing" seems to be the answer from those individuals who keep $3 trillion stashed in money funds yielding about 3.5%, 10 basis points more than the 3.4% increase in the consumer price index in the latest 12 months, but less than that after rendering unto Uncle Sam.
Those in the very top federal tax bracket of 37%, plus the net investment income tax of 3.8%, net a little over 2% from money-market yield. A relatively well-off married couple earning over $250,000, who would face a 27.8% rate including the 3.8% NIIT, would need a pretax yield of 4.71% just to stay even with inflation. That doesn't count state and local taxes (which can be avoided by sticking to Treasury securities).
That's not a terribly high bar to clear. The benchmark 10-year Treasury note yielded about 4.70% this past week. But the iShares 7-10 Year Treasury Bond exchange-traded fund, which tracks that section of the yield curve, has had a negative 1.07% total return for the year through Aug. 12, according to Morningstar. Given ineluctable bond math -- prices go down when yields rise -- risk-averse investors aren't abandoning money markets.
While it's always dangerous to generalize from anecdotes, some folks I've heard who have sold businesses for a nice chunk of change are content to stick with T-bills. They're the polar opposite of Gen Z day traders who, as Bob Dylan famously sang, "ain't got nothin' and got nothin' to lose."
But what's the answer for those who aren't so well off and have to stay ahead of inflation and taxes and want to do so without taking on risk? "That's the great, several-million-dollar question," says Abhijeet Patwardhan, portfolio manager of the FPA New Income fund. Unfortunately, there are no magic answers, he quickly adds.
Higher-yielding corporate bonds provide only a slim spread over government securities, while longer-maturity Treasuries are a "dangerous path to go down," he says, given the aforementioned price risk from rising yields.
Despite benign readings from July's CPI report this past week, Patwardhan favors Treasury inflation-protected securities, but sticking with relatively conservative maturities. To illustrate, the five-year TIPS yielded 2.08% this past Thursday, while the five-year nominal Treasury note yielded 4.32%.
The so-called break-even -- the difference between the two yields, representing the market's expectations for the CPI for the next five years -- is just 2.24%, which would be roughly in line with the Federal Reserve's 2% target for the personal consumption expenditures price index, its preferred inflation gauge. If the Fed continues to miss on the high side, TIPS do better. To be sure, investors still owe taxes on the annual inflation adjustment on TIPS even though they don't get it until maturity.
To stay meaningfully ahead of inflation means taking on some risk. For Charles Lieberman, chief investment officer at Advisors Capital Management, who specializes in income-oriented investing, that means leaning on equities to generate dividends that keep up with inflation.
That has led him to position clients' portfolios to companies leveraged to inflation, notably real estate and oil-and-gas pipelines. In the case of the former, inflation boosts the value of buildings and lifts rents while also eroding the real cost of debt to finance the property, he says.
Healthcare-related properties are attractive, notably nursing homes, which were battered during the pandemic but benefit from an aging population. Among the real estate investment trusts he favors in the sector are Omega Healthcare Investors, with a yield of 5.8%; Sabra Healthcare REIT, yielding 5.9%; and LTC Properties, also yielding 5.9%.
Hotels are benefiting from the travel boom, Lieberman continues. Host Hotels & Resorts owns lots of resort hotels and yields 3.5%. Park Hotels Resorts, which yields 6.7%, also owns destination hotels but has been affected by the 2023 fires in Maui, Hawaii. Another vacation play is Carnival, the cruise line, which he says trades at an inexpensive price/earnings multiple of 12.7 times estimated earnings for the November 2026 fiscal year and has paid down debt taken on during the pandemic. Yield is 2.2%.
He also invests in office buildings via commercial mortgage REITs, mostly leaders in the sector. Among them are Starwood Property Trust, with an 11.7% yield, and Blackstone Mortgage Trust, yielding 13.2%. Ladder Capital is a small-capitalization hybrid commercial mortgage REIT that originates loans, invests in mortgage securities, and invests in properties; yield is 9.33%.
Among pipelines, less-known names that Lieberman likes include Kinetik Holdings, a midstream company with exposure to the Permian Basin, with a 6.3% yield. What also attracts him is that Kinetik could be a "bite size" acquisition for a bigger company, although he isn't buying it as a takeover play. Among the majors in the sector are Williams Cos. and Kinder Morgan, yielding 2.8% and 3.7%, respectively.
Finally, among Lieberman's picks are financial stocks, including the big money-center banks, notably Wells Fargo for its relatively modest valuation and room to grow as regulatory restrictions end. And he likes Lincoln National, a life insurer that he said "hit a speed bump a couple of years ago" from having to write down its capital base. He sees the stock being "back on track" with a 4% yield and selling for under six times current year earnings-per-share estimates.
Clearly, investors have to accept some risk to keep ahead of inflation and taxes. Shorter-term TIPS and income-oriented equities are two potential answers to that conundrum.
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