But research shows that it doesn’t make sense to completely abandon the stock market during the summer months, particularly when it comes to individual sectors. Not all of them will decline.

There are several ways to seize gains if you want to make some portfolio adjustments. Here are two approaches.

GO DEFENSIVE

For those who remember the nasty summer of 2011, when stocks got blistered by European and U.S. debt fears, it didn’t hurt to be in dividend-paying companies that Wall Streeters consider defensive plays. While not immune from market declines, their prices tend to hold up better than for non-dividend payers.

According to the Leuthold Group, holding defensive stocks from May to October yielded a nearly 16 percent gain since 1990 (through April 2013) compared to 9 percent for the Standard & Poor’s 500 index.

When both trading and weather heat up, healthcare and utilities tend to outperform. Both sectors are doing well this year, with almost 23 percent and 15-percent returns through May 17, respectively.

Wall Street mavens may have already embraced healthcare as a defensive move, which is the top sector now in the S&P 500. The Health Care Select SPDR has risen 24 percent year to date and averaged 20 percent over the past three years. This exchange-traded fund holds household names like Johnson & Johnson, Pfizer Inc and Merck & Co Inc.

The Vanguard Utilities Index ETF holds Duke Energy (DUK), American Electric Power and Pacific Gas & Electric in a basket of utilities. The fund has grown 17 percent year to date and averaged 15 percent over three years. It has a 3.6 percent yield, a bonus for income-oriented investors.

PICK A LAGGING SECTOR

Sometimes it seems like big money managers move on a whim, but they often engage in “sector rotation,” meaning they switch from one group of stocks to another depending upon valuations. Typically that translates into a herd-like drive from a popular sector to a lagging one.

In terms of today’s market, such a shift could favor the two weakest groups within the S&P 500 Index: Materials and Information Technology.

These two sectors have only gained about 9 percent and 10 percent, respectively, this year through May 17. That’s about half the 18 percent gain by the S&P 500 Index.

Buying a sector when it is out of favor can lead to healthy gains. If institutional managers are looking for bargains, this is where they might turn.

Why have these companies not enjoyed the kind of popularity enjoyed by hot consumer discretionary and financials? There’s no solid reason except that they are less in favor in a still-recovering economy. If employment and economic growth continue apace, the picture could change.

The best candidates for investing in materials and tech stocks are the Materials Select Sector SPDR, an index-based ETF that holds chemical companies like DuPont, mining firms like Freeport McMoRan Copper & Gold and International Paper Co. The fund was up 10 percent year to date through May 17 and averaged 12 percent over the past three years.

The Vanguard Information Technology ETF owns tech giants such as Apple Inc, International Business Machines Corp and Google Inc. It has risen more than 11 percent year to date and nearly 13 percent over the past three years.

Despite the appeal of anticipating the market, these seasonal moves are not guaranteed to beat any summer swoon or correction. Only make a tactical move to defensive stocks if you feel you’re taking too much risk or spooked by volatility in the general stock market.

And be sure to proceed with caution: Should you decide to bolster your portfolio in this way, you may have to sell other stock positions, which will trigger commissions if you own ETFs, in addition to possible capital gains outside of retirement accounts.

Doing nothing is a third option, naturally. If you’re happy with your general stock allocation – and it meets your objectives – you will ride the market’s wave if you hold a broad-market ETF or mutual fund, assuming stocks continue to climb.

(The author is a Reuters columnist and the opinions expressed are his own.)

(Follow us @ReutersMoney or here Editing by Lauren Young and Richard Chang)

But research shows that it doesn’t make sense to completely
abandon the stock market during the summer months, particularly
when it comes to individual sectors. Not all of them will
decline.

There are several ways to seize gains if you want to make
some portfolio adjustments. Here are two approaches.

GO DEFENSIVE

For those who remember the nasty summer of 2011, when stocks
got blistered by European and U.S. debt fears, it didn’t hurt to
be in dividend-paying companies that Wall Streeters consider
defensive plays. While not immune from market declines, their
prices tend to hold up better than for non-dividend payers.

According to the Leuthold Group, holding defensive stocks
from May to October yielded a nearly 16 percent gain since 1990
(through April 2013) compared to 9 percent for the Standard &
Poor’s 500 index.

When both trading and weather heat up, healthcare and
utilities tend to outperform. Both sectors are doing well this
year, with almost 23 percent and 15-percent returns through May
17, respectively.

Wall Street mavens may have already embraced healthcare as a
defensive move, which is the top sector now in the S&P 500. The
Health Care Select SPDR has risen 24 percent year to
date and averaged 20 percent over the past three years. This
exchange-traded fund holds household names like Johnson &
Johnson, Pfizer Inc and Merck & Co Inc.

The Vanguard Utilities Index ETF holds Duke Energy
(DUK), American Electric Power and Pacific Gas &
Electric in a basket of utilities. The fund has grown
17 percent year to date and averaged 15 percent over three
years. It has a 3.6 percent yield, a bonus for income-oriented
investors.

PICK A LAGGING SECTOR

Sometimes it seems like big money managers move on a whim,
but they often engage in “sector rotation,” meaning they switch
from one group of stocks to another depending upon valuations.
Typically that translates into a herd-like drive from a popular
sector to a lagging one.

In terms of today’s market, such a shift could favor the two
weakest groups within the S&P 500 Index: Materials and
Information Technology.

These two sectors have only gained about 9 percent and 10
percent, respectively, this year through May 17. That’s about
half the 18 percent gain by the S&P 500 Index.

Buying a sector when it is out of favor can lead to healthy
gains. If institutional managers are looking for bargains, this
is where they might turn.

Why have these companies not enjoyed the kind of popularity
enjoyed by hot consumer discretionary and financials? There’s no
solid reason except that they are less in favor in a
still-recovering economy. If employment and economic growth
continue apace, the picture could change.

The best candidates for investing in materials and tech
stocks are the Materials Select Sector SPDR, an
index-based ETF that holds chemical companies like DuPont
, mining firms like Freeport McMoRan Copper & Gold
and International Paper Co. The fund was up 10 percent
year to date through May 17 and averaged 12 percent over the
past three years.

The Vanguard Information Technology ETF owns tech
giants such as Apple Inc, International Business
Machines Corp and Google Inc. It has risen more
than 11 percent year to date and nearly 13 percent over the past
three years.

Despite the appeal of anticipating the market, these
seasonal moves are not guaranteed to beat any summer swoon or
correction. Only make a tactical move to defensive stocks if you
feel you’re taking too much risk or spooked by volatility in the
general stock market.

And be sure to proceed with caution: Should you decide to
bolster your portfolio in this way, you may have to sell other
stock positions, which will trigger commissions if you own ETFs,
in addition to possible capital gains outside of retirement
accounts.

Doing nothing is a third option, naturally. If you’re happy
with your general stock allocation – and it meets your
objectives – you will ride the market’s wave if you hold a
broad-market ETF or mutual fund, assuming stocks continue to
climb.

BDCs are companies that lend to young, thinly traded and often distressed companies that have credit ratings in the “junk” status. They are as close to a private equity enterprise as you’re going to get in a public company. Yet their high yields come at a price in terms of elevated risk that should not be underestimated, and investors must proceed with caution.

Like Real Estate Investment Trusts (REITs), BDCs must pass through at least 90 percent of their profit to shareholders. Most of their borrowers carry the lowest-possible credit ratings such as BBB-, or are not rated at all. They hold a variety of companies in their portfolios, so some are more diversified than others.

As high-yield vehicles, BDCs have been emerging at a relatively rapid clip in recent years. There were just four of them nine years ago. Now, there are nearly 30, with a total market capitalization of $26 billion, according to Financial Advisor, a trade magazine. That’s peanuts compared with megabanks like JPM Morgan Chase & Co or Bank of America Corp, but they are a growing force in corporate finance.

While regulated, BDCs occupy a useful niche in helping companies grow. Since they can borrow at record-low rates and make money on the spread – the above-market rates they charge less credit-worthy borrowers – BDCs are in a sweet spot now as the economy continues to rebound. They can provide financing to a wide range of companies typically eschewed by mainstream banks. Consider them sub-prime lenders to small- to mid-size companies.

If you’re going to hold BDCs at all, it’s best to own a diversified portfolio of them through an exchange-traded fund or note. There are currently two products on the market that hold BDCs. Both of them are new, so there is not much of a track record to evaluate.

The UBS ETRACS Wells Fargo Business Development Company Exchange-traded note tracks an index of BDCs and pays a 6.7 percent yield. It has gained 6 percent year-to-date and returned nearly 30 percent over the past year through May 15. Holdings include 28 BDCs such as Ares Capital Corp, which specializes in financing private middle-market companies, and Prospect Capital Corp, which provides debt and equity capital to the same market.

The Market Vectors BDC Income ETF offers a 7.6 percent yield, but has been on the market only since February. It holds 26 companies including American Capital Ltd and Fifth Street Finance Corp and has returned 3 percent over the past three months through May 15.

WARNINGS

Be careful with these vehicles as regulators and certified financial planners have raised concerns. Earlier this year, FINRA, the securities industry self-regulator, singled out BDCs for their “significant market, credit and liquidity risks.” The availability of low-cost financing means BDCs “run the risk of overleveraging their relatively illiquid portfolios,” FINRA noted.

Not all of the BDCs are publicly traded. The nontraded variety, sold through brokers who take commissions up to 7 percent, pose even higher risks because there may be no viable secondary market for them. Both nontraded and traded BDCs are highly volatile.

“If you don’t like the volatility of publicly traded BDCs. There are always nontraded ones, but then you have nonliquidity risk,” says Gary Alt, a certified financial planner and partner with Monterey Private Wealth in Monterey, California.

“The capital markets didn’t understand this risk fully until 2008 and 2009 when all the money from banks dried up,” Alt adds. “For investors accustomed to getting income from bonds, they better be ready for a wild ride with BDCs.”

Although ETFs solve one problem by diversifying among many of the companies, they are still concentrating risk within a small, volatile sector of the financial services industry.

“Diversification is not the problem,” notes Don Martin, a certified financial planner with Mayflower Capital in Los Altos, California. “The real problem is that the asset class is too risky. I would be very wary of investing in a BDC and would be suspicious of any high-yield product.”

Given their high-risk profiles, BDCs are not a comparable substitute for Treasuries, mortgage securities, municipals or corporates in your portfolio.

If you are risk-averse, they are not for you. I wouldn’t wait to see how they hold up in a down market. I would only approach them as an alternative for less than 2 percent of your holdings if you can add them to your portfolio to supplement – but not replace – your other income vehicles.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

(Editing by Lauren Young and Matthew Lewis)

BDCs are companies that lend to young, thinly traded and
often distressed companies that have credit ratings in the
“junk” status. They are as close to a private equity enterprise
as you’re going to get in a public company. Yet their high
yields come at a price in terms of elevated risk that should not
be underestimated, and investors must proceed with caution.

Like Real Estate Investment Trusts (REITs), BDCs must pass
through at least 90 percent of their profit to shareholders.
Most of their borrowers carry the lowest-possible credit ratings
such as BBB-, or are not rated at all. They hold a variety of
companies in their portfolios, so some are more diversified than
others.

As high-yield vehicles, BDCs have been emerging at a
relatively rapid clip in recent years. There were just four of
them nine years ago. Now, there are nearly 30, with a total
market capitalization of $26 billion, according to Financial
Advisor, a trade magazine. That’s peanuts compared with
megabanks like JPM Morgan Chase & Co or Bank of America
Corp, but they are a growing force in corporate finance.

While regulated, BDCs occupy a useful niche in helping
companies grow. Since they can borrow at record-low rates and
make money on the spread – the above-market rates they charge
less credit-worthy borrowers – BDCs are in a sweet spot now as
the economy continues to rebound. They can provide financing to
a wide range of companies typically eschewed by mainstream
banks. Consider them sub-prime lenders to small- to mid-size
companies.

If you’re going to hold BDCs at all, it’s best to own a
diversified portfolio of them through an exchange-traded fund or
note. There are currently two products on the market that hold
BDCs. Both of them are new, so there is not much of a track
record to evaluate.

The UBS ETRACS Wells Fargo Business Development Company
Exchange-traded note tracks an index of BDCs and pays a 6.7
percent yield. It has gained 6 percent year-to-date and returned
nearly 30 percent over the past year through May 15. Holdings
include 28 BDCs such as Ares Capital Corp, which
specializes in financing private middle-market companies, and
Prospect Capital Corp, which provides debt and equity
capital to the same market.

The Market Vectors BDC Income ETF offers a 7.6
percent yield, but has been on the market only since February.
It holds 26 companies including American Capital Ltd
and Fifth Street Finance Corp and has returned 3 percent
over the past three months through May 15.

WARNINGS

Be careful with these vehicles as regulators and certified
financial planners have raised concerns. Earlier this year,
FINRA, the securities industry self-regulator, singled out BDCs
for their “significant market, credit and liquidity risks.” The
availability of low-cost financing means BDCs “run the risk of
overleveraging their relatively illiquid portfolios,” FINRA
noted.

Not all of the BDCs are publicly traded. The nontraded
variety, sold through brokers who take commissions up to 7
percent, pose even higher risks because there may be no viable
secondary market for them. Both nontraded and traded BDCs are
highly volatile.

“If you don’t like the volatility of publicly traded BDCs.
There are always nontraded ones, but then you have nonliquidity
risk,” says Gary Alt, a certified financial planner and partner
with Monterey Private Wealth in Monterey, California.

“The capital markets didn’t understand this risk fully until
2008 and 2009 when all the money from banks dried up,” Alt adds.
“For investors accustomed to getting income from bonds, they
better be ready for a wild ride with BDCs.”

Although ETFs solve one problem by diversifying among many
of the companies, they are still concentrating risk within a
small, volatile sector of the financial services industry.

“Diversification is not the problem,” notes Don Martin, a
certified financial planner with Mayflower Capital in Los Altos,
California. “The real problem is that the asset class is too
risky. I would be very wary of investing in a BDC and would be
suspicious of any high-yield product.”

Given their high-risk profiles, BDCs are not a comparable
substitute for Treasuries, mortgage securities, municipals or
corporates in your portfolio.

If you are risk-averse, they are not for you. I wouldn’t
wait to see how they hold up in a down market. I would only
approach them as an alternative for less than 2 percent of your
holdings if you can add them to your portfolio to supplement -
but not replace – your other income vehicles.

Despite the lure of recent market gains, there’s often no pattern to investment results. To avoid seeing patterns where there may be none – and acting irrationally – we often need to short-circuit our instincts and think counter-intuitively.

A go-slow approach that avoids trading on market timing can often avert losses. Here are some behavioral biases and ways to prevent bad decisions:

1. Don’t time jumps in and out of the market.

Trading decisions typically are expensive and eat into your total return.

A study released late last year by the Gerstein Fisher research center found that the S&P 500 posted a 6.66 percent annualized return from January 1, 1996, through December 31, 2010. After trading, inflation, fund expenses and taxes, however, individuals reaped a miserable 1 percent return. Investors paid a steep penalty for market timing.

2. Buy and hold works.

We tend to be overconfident in our ability to predict the future.

Let’s say you held a basket of small-company stocks from 1993 through last year. You would have reaped an 11 percent compound annual return, according to Ibbotson Associates. If you were in large stocks, your gain would have been about 8 percent on average annually if you held your position for 20 years through 2011, according to Dalbar, a Boston-based financial research firm.

Most investors didn’t stay still. They lagged the S&P 500 index by more than four percentage points. Keep in mind that this period included more than two recessions and two major market sell-offs.

Trading can be expensive, too, even when you think you’re being cautious. Let’s look at 2011, a particularly volatile year. Stock-market investors studied by Dalbar lost 5.73 percent when they cashed out at the sign of trouble. Simply holding the S&P 500 would have netted them a slight gain.

3. Immediate past results don’t predict future returns.

When a market reaches new heights, investors fall prey to what behavioral economists call “hindsight bias.”

We tend to overestimate the possibility that immediate past performance will continue. As a result, the herd flowing into the market often gets in at the peak, just before a decline.

Burned investors tend to head in the wrong direction. Look at two years of the current bull market – 2010 and 2011 – when it would have been a good time to get in on the early stages of the record-setting ascent following the financial crash.

Some $370 billion poured into bond mutual funds during those years, according to the Investment Company Institute, compared to an outflow of nearly $140 billion from stock funds.

Of course, there’s no way to predict how long a rally or downturn will last. That’s why it’s best to look to your own goals, not major market turns, to anchor your decisions.

4. My stocks will bounce back.

The hardest thing to do emotionally is to take a loss and move on. A notable research paper by Terrance Odean of the University of California, Berkeley, demonstrated that the aversion to dumping losers is common and costly. He found that investors could have earned a 4.4 percent better return if they had sold them while holding onto winners.

Often we buy stocks or funds because we’re sentimentally connected to them or simply a lot of other people are buying them. If millions of others like something, it has to be good, right? Wrong – and it doesn’t mean they’ll be good investments in the future, either.

That’s why it’s important to pay attention to the purchase price and where the stock is headed. Compare price/earnings ratios against similar stocks. Are they overpriced? What’s the direction of the company and competition?

Most of all, get over what Daniel Kahneman, Nobel Prize winner in economics and author of the best-selling book “Thinking Fast and Slow,” calls the “delusion of control” that many investors possess when viewing the market. The only things within your power are how much you pay for your investments, how often you put money to work and how much you save.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

(Follow us @ReutersMoney or here Editing by Lauren Young and Prudence Crowther)

Despite the lure of recent market gains, there’s often no
pattern to investment results. To avoid seeing patterns where
there may be none – and acting irrationally – we often need to
short-circuit our instincts and think counter-intuitively.

A go-slow approach that avoids trading on market timing can
often avert losses. Here are some behavioral biases and ways to
prevent bad decisions:

1. Don’t time jumps in and out of the market.

Trading decisions typically are expensive and eat into your
total return.

A study released late last year by the Gerstein Fisher
research center found that the S&P 500 posted a 6.66 percent
annualized return from Jan. 1, 1996, through Dec. 31, 2010.
After trading, inflation, fund expenses and taxes, however,
individuals reaped a miserable 1 percent return. Investors paid
a steep penalty for market timing.

2. Buy and hold works.

We tend to be overconfident in our ability to predict the
future.

Let’s say you held a basket of small-company stocks from
1993 through last year. You would have reaped an 11 percent
compound annual return, according to Ibbotson Associates. If you
were in large stocks, your gain would have been about 8 percent
on average annually if you held your position for 20 years
through 2011, according to Dalbar, a Boston-based financial
research firm.

Most investors didn’t stay still. They lagged the S&P 500
index by more than four percentage points. Keep in mind that
this period included more than two recessions and two major
market sell-offs.

Trading can be expensive, too, even when you think you’re
being cautious. Let’s look at 2011, a particularly volatile
year. Stock-market investors studied by Dalbar lost 5.73 percent
when they cashed out at the sign of trouble. Simply holding the
S&P 500 would have netted them a slight gain.

3. Immediate past results don’t predict future returns.

When a market reaches new heights, investors fall prey to
what behavioral economists call “hindsight bias.”

We tend to overestimate the possibility that immediate past
performance will continue. As a result, the herd flowing into
the market often gets in at the peak, just before a decline.

Burned investors tend to head in the wrong direction. Look
at two years of the current bull market – 2010 and 2011 – when
it would have been a good time to get in on the early stages of
the record-setting ascent following the financial crash.

Some $370 billion poured into bond mutual funds during those
years, according to the Investment Company Institute, compared
to an outflow of nearly $140 billion from stock funds.

Of course, there’s no way to predict how long a rally or
downturn will last. That’s why it’s best to look to your own
goals, not major market turns, to anchor your decisions.

4. My stocks will bounce back.

The hardest thing to do emotionally is to take a loss and
move on. A notable research paper by Terrance Odean of the
University of California, Berkeley, demonstrated that the
aversion to dumping losers is common and costly. He found that
investors could have earned a 4.4 percent better return if they
had sold them while holding onto winners.

Often we buy stocks or funds because we’re sentimentally
connected to them or simply a lot of other people are buying
them. If millions of others like something, it has to be good,
right? Wrong – and it doesn’t mean they’ll be good investments
in the future, either.

That’s why it’s important to pay attention to the purchase
price and where the stock is headed. Compare price/earnings
ratios against similar stocks. Are they overpriced? What’s the
direction of the company and competition?

Most of all, get over what Daniel Kahneman, Nobel Prize
winner in economics and author of the best-selling book
“Thinking Fast and Slow,” calls the “delusion of control” that
many investors possess when viewing the market. The only things
within your power are how much you pay for your investments, how
often you put money to work and how much you save.

While attention has been on the record-setting stock market – the Dow Jones Industrial Average closed above the symbolic 15,000 on Tuesday and kept climbing – bond yields have been heading south. The benchmark 10-year U.S. Treasury is yielding around 1.8 percent after hitting 2 percent in early March.

An “in-between” portfolio that focuses on yield from non-traditional sources while owning dividend-rich stocks is one approach to find income. This strategy is based on the reality that bond yields probably won’t rise much in the next year or so. You’ll have to venture into alternative investments if you want to boost your income stream.

I’ve searched for some of the best exchange-traded funds (ETFs) that offer income and appreciation. The following ETFs focus on four key themes: Global stock dividends, master limited partnerships (MLPs), high-yield bonds and real-estate investment trusts (REITs).

Dividend-paying stocks, for example, can outpace inflation. In January 2009, the S&P 500 Index dividend yield was 3.24 percent while the Consumer Price Index was a negative 0.34 percent, according to dividend.com.

That doesn’t always happen. Even so, cash-rich companies are in a better position to raise dividends – something bond payers can’t do.

This mix is not risk-free. It may get hit as hard in a stock market sell-off, which is why these funds should comprise no more than 15 percent of your total holdings.

HIGH-DIVIDEND GLOBAL STOCKS

The PowerShares International Dividend Achievers ETF gives you a selection of dividend payers from around the world. If something happens to the torrid U.S. market, you have a little insulation.

The fund, which yields just above two percent, holds brand-name non-U.S. stocks like Vodaphone and Nippon Telegraph and Telephone.

It’s posted an annualized return of nearly 14-percent during the three years through May 8, and is up 20 percent for the past year through that date. The trade-off, however, is that the fund is more volatile than the S&P 500.

MORTGAGE REITS

REITs that invest in mortgages have done well since 2008, thanks to low financing rates, although they are not well known. The iShares FTSE NAREIT Mortgage PlusCapped Index invests in major REITs like Annaly Capital Management, which buys mortgage pass-through certificates and obligations.

This specialized REIT borrows money to buy mortgage-backed securities. Like all REITs, it must pass through 90 percent of its income to shareholders.

Currently, the iShares fund is yielding 11 percent. The downside is that it trades like a stock, and its risk is roughly the same as the S&P 500. It’s up 24 percent through May 8, and has averaged an annualized gain of 15 percent during the past three years.

MASTER LIMITED PARTNERSHIPS

Until recently, you could only buy these vehicles through brokers, often paying steep commissions. Now that they’re being packaged in ETFs, they are worth considering for their high yields, which range from 7 percent to 16 percent.

The Alerian MLP ETF, up 15 percent in the past year through May 8, holds an index of energy partnerships that mostly invested in pipeline companies. With an almost 6-percent yield, the fund probably won’t move in lockstep with common stocks, but it’s prone to declines if oil prices slide. The ETF is less than two years old, so it’s too young to have risk measures.

HIGH-YIELD BONDS

Unlike their government counterparts, “junk” bonds give you the trade-off of lower credit ratings in exchange for higher yields. Rated “B” and lower, these are companies that still need to sell debt, but pose a higher risk of default.

Packaged within an ETF such as the Peritus High-Yield ETF, you can find some diversification from credit risk. Although it is actively managed and has a much higher expense ratio than its peers – 1.35 percent annually versus 0.4 percent for a similar indexed fund – the Peritus fund sports an 8 percent yield.

It is up 13 percent for the year, besting its benchmark by 2 percentage points, which is a significant advantage in the bond world.

As a backstop, keep a close eye on interest rates with all of your bond holdings.

“Be tactical so that you can be ready for the eventual rising interest-rate environment,” advises John Zhong, chief executive officer and founder of MyPlanIQ.com, a portfolio service.

(The author is a Reuters columnist. The opinions expressed are his own.)

(Editing by Lauren Young and Bernadette Baum)

While attention has been on the record-setting stock market
- the Dow Jones Industrial Average closed above the symbolic
15,000 on Tuesday and kept climbing – bond yields have been
heading south. The benchmark 10-year U.S. Treasury is yielding
around 1.8 percent after hitting 2 percent in early March.

An “in-between” portfolio that focuses on yield from
non-traditional sources while owning dividend-rich stocks is one
approach to find income. This strategy is based on the reality
that bond yields probably won’t rise much in the next year or
so. You’ll have to venture into alternative investments if you
want to boost your income stream.

I’ve searched for some of the best exchange-traded funds
(ETFs) that offer income and appreciation. The following ETFs
focus on four key themes: Global stock dividends, master limited
partnerships (MLPs), high-yield bonds and real-estate investment
trusts (REITs).

Dividend-paying stocks, for example, can outpace inflation.
In January 2009, the S&P 500 Index dividend yield was 3.24
percent while the Consumer Price Index was a negative 0.34
percent, according to dividend.com.

That doesn’t always happen. Even so, cash-rich companies are
in a better position to raise dividends – something bond payers
can’t do.

This mix is not risk-free. It may get hit as hard in a stock
market sell-off, which is why these funds should comprise no
more than 15 percent of your total holdings.

HIGH-DIVIDEND GLOBAL STOCKS

The PowerShares International Dividend Achievers ETF
gives you a selection of dividend payers from around the world.
If something happens to the torrid U.S. market, you have a
little insulation.

The fund, which yields just above two percent, holds
brand-name non-U.S. stocks like Vodaphone and Nippon
Telegraph and Telephone.

It’s posted an annualized return of nearly 14-percent during
the three years through May 8, and is up 20 percent for the past
year through that date. The trade-off, however, is that the fund
is more volatile than the S&P 500.

MORTGAGE REITS

REITs that invest in mortgages have done well since 2008,
thanks to low financing rates, although they are not well known.
The iShares FTSE NAREIT Mortgage PlusCapped Index
invests in major REITs like Annaly Capital Management,
which buys mortgage pass-through certificates and obligations.

This specialized REIT borrows money to buy mortgage-backed
securities. Like all REITs, it must pass through 90 percent of
its income to shareholders.

Currently, the iShares fund is yielding 11 percent. The
downside is that it trades like a stock, and its risk is roughly
the same as the S&P 500. It’s up 24 percent through May 8, and
has averaged an annualized gain of 15 percent during the past
three years.

MASTER LIMITED PARTNERSHIPS

Until recently, you could only buy these vehicles through
brokers, often paying steep commissions. Now that they’re being
packaged in ETFs, they are worth considering for their high
yields, which range from 7 percent to 16 percent.

The Alerian MLP ETF, up 15 percent in the past year
through May 8, holds an index of energy partnerships that mostly
invested in pipeline companies. With an almost 6-percent yield,
the fund probably won’t move in lockstep with common stocks, but
it’s prone to declines if oil prices slide. The ETF is less than
two years old, so it’s too young to have risk measures.

HIGH-YIELD BONDS

Unlike their government counterparts, “junk” bonds give you
the trade-off of lower credit ratings in exchange for higher
yields. Rated “B” and lower, these are companies that still need
to sell debt, but pose a higher risk of default.

Packaged within an ETF such as the Peritus High-Yield ETF
, you can find some diversification from credit risk.
Although it is actively managed and has a much higher expense
ratio than its peers – 1.35 percent annually versus 0.4 percent
for a similar indexed fund – the Peritus fund sports an 8
percent yield.

It is up 13 percent for the year, besting its benchmark by 2
percentage points, which is a significant advantage in the bond
world.

As a backstop, keep a close eye on interest rates with all
of your bond holdings.

“Be tactical so that you can be ready for the eventual
rising interest-rate environment,” advises John Zhong, chief
executive officer and founder of MyPlanIQ.com, a portfolio
service.

These funds now represent the second-most-popular allocation after U.S. large-stock funds within defined-contribution plans like 401(k) accounts, according to pension consultant Callan Associates. Target-date assets have climbed above $500 billion, attracting $16 billion in the first two months of 2013 alone, according to Strategic Insight.

Target-date funds combine several mutual funds within one package and are managed so that they move to less risky postures as their shareholders move closer to retirement. That movement – usually from stocks to bonds – is called the fund’s “glide path.” The funds take aim at specific future dates, and investors are expected to buy the fund that matches their own retirement date.

Investors may find themselves automatically invested in these funds: Target-date funds are approved by the U.S. Department of Labor as a default choice in 401(k)s, so some plan managers use them whenever they automatically enroll employees.

All that might suggest the funds are fairly risk-free. But while diversification strategies can reduce risk, they don’t eliminate it. Some target-date funds are much more volatile than others, depending upon their allocation. Their internal risks are poorly understood, fund expenses are high and they yield varying results. Here’s what investors may be missing:

BOND RISKS

The premise behind most of the glide paths is that bonds are safer than stocks. But when interest rates rise, bond prices fall, so bond funds within target-date funds are likely to lose money. And sooner or later, either a recovering economy or improving job situation will compel the Federal Reserve to raise interest rates. A legion of market observers are warning of a decline in the bond market, which is said to be nearing the end of a 30-year bull run.

Then there’s inflation. If consumer prices begin to rise more rapidly, that could hit your target-date bond holdings too. Does yours have a stake in Treasury inflation-protected securities (TIPS), which pay a premium if the cost-of-living increases? Many funds lack sufficient protection against this enemy of bond holders.

STOCK RISKS

While many investors may think target-date funds reduce risk over time, they still have large exposures to the stock market. That helps retirement investors keep their portfolios growing over the long term but also leaves them vulnerable to a market sell-off. For example, the T. Rowe Price 2020 fund performed poorly in 2008, with a 33 percent loss.

That fund keeps 69 percent of its portfolio in stocks and more than 26 percent stake in bonds, with the remainder in cash, and it is almost as volatile as a broad-market S&P 500 Index fund. During bull markets, though, that aggressive stance has paid off for fund holders: It’s up 8 percent year to date through May 6.

Other target market funds are less aggressive. The Schwab 2020 fund, with the lowest volatility in this group at just over 13, has a lower stake in stocks, at 58 percent with the remainder in bonds and cash. It lost 26 percent in 2008. It’s up 7.5 percent year to date through May 6.

HIGH COSTS

Target-date fund holders pay dearly for convenience, shelling out as much for a group of mostly passive funds as they would for an actively managed fund.

Expenses for funds with target dates ranging from 2016-2020 averaged 0.71 percent, just slightly lower than the 0.78 percent average for more than 300 U.S. active stock funds tracked by Morningstar. Furthermore, higher-priced target-date funds do not deliver better performance than the lower-priced ones, according to a study by Marc Fandetti, principal of the Meketa Investment Group in Westwood, Massachusetts.

As is often the case, the Vanguard Retirement 2020 (VTWNX) fund is a low-cost option. It charges 0.16 percent annually. Through last year the fund held 63 percent in stocks, 33 percent in bonds and the remainder in cash. It lost 27 percent in 2008 and is up 7.76 percent year to date through May 6.

OTHER APPROACHES

Instead of the prepackaged solution, consider owning separate stock and bond index funds, so you can adjust your own allocation between them to reflect your risk tolerance.

Are you close to retirement and concerned about inflation? Look at funds that invest in real estate investment trusts (REITs), dividend-paying stocks, commodities or precious metals.

“Hedge your urgent needs,” says Zvi Bodie, a finance professor at Boston University and staunch critic of premixed funds of funds. “Only risk wealth that you can afford to lose. The providers of target are not offering guarantees.”

(The author is a Reuters columnist and the opinions expressed are his own.)

(Follow us @ReutersMoney or here Editing by Linda Stern and Prudence Crowther)

These funds now represent the second-most-popular allocation
after U.S. large-stock funds within defined-contribution plans
like 401(k) accounts, according to pension consultant Callan
Associates. Target-date assets have climbed above $500 billion,
attracting $16 billion in the first two months of 2013 alone,
according to Strategic Insight.

Target-date funds combine several mutual funds within one
package and are managed so that they move to less risky postures
as their shareholders move closer to retirement. That movement -
usually from stocks to bonds – is called the fund’s “glide
path.” The funds take aim at specific future dates, and
investors are expected to buy the fund that matches their own
retirement date.

Investors may find themselves automatically invested in
these funds: Target-date funds are approved by the U.S.
Department of Labor as a default choice in 401(k)s, so some plan
managers use them whenever they automatically enroll employees.

All that might suggest the funds are fairly risk-free. But
while diversification strategies can reduce risk, they don’t
eliminate it. Some target-date funds are much more volatile than
others, depending upon their allocation. Their internal risks
are poorly understood, fund expenses are high and they yield
varying results. Here’s what investors may be missing:

BOND RISKS

The premise behind most of the glide paths is that bonds are
safer than stocks. But when interest rates rise, bond prices
fall, so bond funds within target-date funds are likely to lose
money. And sooner or later, either a recovering economy or
improving job situation will compel the Federal Reserve to raise
interest rates. A legion of market observers are warning of a
decline in the bond market, which is said to be nearing the end
of a 30-year bull run.

Then there’s inflation. If consumer prices begin to rise
more rapidly, that could hit your target-date bond holdings too.
Does yours have a stake in Treasury inflation-protected
securities (TIPS), which pay a premium if the cost-of-living
increases? Many funds lack sufficient protection against this
enemy of bond holders.

STOCK RISKS

While many investors may think target-date funds reduce risk
over time, they still have large exposures to the stock market.
That helps retirement investors keep their portfolios growing
over the long term but also leaves them vulnerable to a market
sell-off. For example, the T. Rowe Price 2020 fund
performed poorly in 2008, with a 33 percent loss.

That fund keeps 69 percent of its portfolio in stocks and
more than 26 percent stake in bonds, with the remainder in cash,
and it is almost as volatile as a broad-market S&P 500 Index
fund. During bull markets, though, that aggressive stance has
paid off for fund holders: It’s up 8 percent year to date
through May 6.

Other target market funds are less aggressive. The Schwab
2020 fund, with the lowest volatility in this group at
just over 13, has a lower stake in stocks, at 58 percent with
the remainder in bonds and cash. It lost 26 percent in 2008.
It’s up 7.5 percent year to date through May 6.

HIGH COSTS

Target-date fund holders pay dearly for convenience,
shelling out as much for a group of mostly passive funds as they
would for an actively managed fund.

Expenses for funds with target dates ranging from 2016-2020
averaged 0.71 percent, just slightly lower than the 0.78 percent
average for more than 300 U.S. active stock funds tracked by
Morningstar. Furthermore, higher-priced target-date funds do not
deliver better performance than the lower-priced ones, according
to a study by Marc Fandetti, principal of the Meketa Investment
Group in Westwood, Massachusetts.

As is often the case, the Vanguard Retirement 2020 (VTWNX)
fund is a low-cost option. It charges 0.16 percent annually.
Through last year the fund held 63 percent in stocks, 33 percent
in bonds and the remainder in cash. It lost 27 percent in 2008
and is up 7.76 percent year to date through May 6.

OTHER APPROACHES

Instead of the prepackaged solution, consider owning
separate stock and bond index funds, so you can adjust your own
allocation between them to reflect your risk tolerance.

Are you close to retirement and concerned about inflation?
Look at funds that invest in real estate investment trusts
(REITs), dividend-paying stocks, commodities or precious metals.

“Hedge your urgent needs,” says Zvi Bodie, a finance
professor at Boston University and staunch critic of premixed
funds of funds. “Only risk wealth that you can afford to lose.
The providers of target are not offering guarantees.”