Tips on how to us ETFs to get income from your savings

ByABC News
June 14, 2012, 8:48 PM

— -- If you're trying to live off the income from your savings, you have a few choices to make. For example, should you dig a well, or drink rainwater? Is 35 degrees too warm to keep the house in winter? And is it really all that wrong to resort to cannibalism?

You're facing these choices because the income you can get from your savings is close to zero. The average yield on a money market fund is 0.03%, according to iMoney.net. On a $1 million account, that's $5.77 a week.

The object today is to cobble together an income portfolio that will get somewhere around 3% a year. It's not much, but it's probably more than what you're getting now. But you'll also be getting more risk.

The maximum yield you can get without risk of losing principal is 2.74%, which is the current yield on a 30-year Treasury bond. To get that yield, you'd have to hold the note for the entire 30 years. And, yes, you'd probably lose money to inflation. If you earn a higher rate than that, you're taking more risk. And the higher the rate, the greater the risk.

So here's a portfolio of exchange traded funds that can help boost the income from your savings. An exchange traded fund is a mutual fund that trades on stock exchanges, just as stocks do. The main advantage of ETFs is that they tend to be very low-cost. When a fund earns 4% in interest from its holdings, you don't want to give away a full percentage point to the fund company.

If you can't stand the thought of taking a loss, this is where you should probably skip over to Savers' Scoreboard (at the bottom of this page), which will guide you to the nation's highest-yielding bank deposits.

We can reduce risk in two ways. The first is keeping a significant position in bank CDs or money market funds. Think of it as a buffer. If you have $10,000 and lose 10%, you'll be left with $9,000. If you keep 30% in CDs and lose 10% on the remainder, you'll have about $9,300 - a 7% loss. Not wonderful, but still better than a 10% loss. Furthermore, we can say with a fair amount of certainty that bank CDs and money funds will yield more in the next five years than they do now. (If not, well, we have other things to worry about.) At any rate, let's put 30% in cash. You can adjust that up or down, depending on your tolerance for risk.

The other way to reduce risk is to diversify broadly among stocks and bonds, in the hope that if one type of investment fumbles, others may score.

We'll put 10% in each of these two bond funds:

•Vanguard Intermediate-term Bond ETF (ticker: BIV), which has yielded 3.70% the past 12 months. It invests in bonds that mature in five to 10 years.

•iShares Barclays TIPS Bond (TIP), which invests in inflation-adjusted Treasury securities and has yielded 3.24% the past 12 months.

We'll add 15% to the SPDR Barclays Capital High Yield Bond (JNK), which includes corporate bonds with low credit ratings. It's called junk for a reason, but its high yield can buffer some losses. Yield: 7.46%.

This leaves us with 35% of the portfolio to fill. Start with a 15% position in WisdomTree Equity Income (DHS), which invests in large, dividend-paying companies such as AT&T, General Electric and Pfizer. Tom Graves, equity analyst at Standard & Poor's Capital IQ, rates it high for growth and stability. Yield: 3.45%.

Add 10% to both:

•Vanguard Utilities ETF (VPU), which will give you low-cost exposure to utility stocks, a traditional area of high dividends and relative stability. Yield: 3.6%.

•Vanguard REIT ETF (VNQ), which invests in real estate investment trusts. Yield: 3.42%.

The average cost of the ETFs: 0.23%, or $23 per $10,000 invested.

Make no mistake: This is no portfolio of bank CDs. The ETF section has averaged a 4.15% yield the past 12 months. The cash allocation brings the yield down to about 3.03%, assuming you get nothing on cash. But if you're willing to take more risk for more return, this portfolio might help you splurge every so often and nudge the thermostat up to 45 degrees.