You can never earn enough money. There's probably a lengthy list of things you want but can't afford -- that new car, new golf clubs, new pair of designer shoes. But what if you had a second income stream? True, you could get a second job, but that's fewer hours in the day you could spend with your family. You could resort to Treasuries or CDs, but they won't give you a very high return on your capital.
So, then, let me recommend income-paying mutual funds. That's right: mutual funds.
They're a good option for investors looking to boost their existing income with a steady second stream. But there are several things to look for to ensure that you're not exposing your savings to more risk than reward.
Less volatility for low price
The one thing we all dread is exposing our savings to high volatility -- one year we're up and doubling our money, while the next year we're crashing through the bottom. But don't despair. Volatility can be measured, even for mutual funds. This is called beta. The beta of a mutual fund measures how volatile the fund is compared with its benchmark. For example, a beta of 1.0 shows that the fund moves in conjunction with its benchmark -- in which case you'd better make sure that it's performing better than that benchmark.
For an example, look at the Vanguard Dividend Growth Fund (VDIGX). Dividend-paying stocks are an excellent source of stable annual income for your portfolio, but with individual stocks you're exposed to a much higher risk of losing your entire investment. With this fund, you have exposure to a diversified basket of dividend-paying stocks including Microsoft
With a beta of 0.88 against the S&P 500 index, you're getting significantly less volatility in a fund that returned 13% per year over the past three years. And all that for an expense ratio of 0.37% and no loads, which is much lower than what you would pay for most funds in this category.
When looking at the managers of a mutual fund, it's always important to take note of how long they've been working there. It can also be enlightening to know whether members of management are confident enough in the fund's performance to invest in it themselves. You can find all of this information in a fund's prospectus and statement of additional information.
For an example, take a look at the Dodge & Cox Income Fund (DODIX). This fixed-income fund uses the bonds of solid companies like Xerox
But another important part of stability is how long management has been part of this great performance. For this Dodge & Cox fund, it's been an average of 13 years. That's long enough for any investor to be confident in the managers' ability to stay on track through economic cycles.
Another thing that is relevant for mutual fund investors is whether the people in management "eat their own cooking." As Shannon Zimmerman, lead analyst for the Motley Fool Champion Funds newsletter, says, funds with high management ownership "tend to be among the most shareholder-friendly in the industry." For the Dodge & Cox Income Fund, all of the managers hold at least a small position in the fund, with most of them holding a significant stake. That makes me more confident in the fund.
Your second income
But before you go rushing off to mutual fund heaven, think about this: Seventy-five percent of all mutual funds underperform the market. That's a staggering statistic to keep in mind as you're searching for the top tier of income funds. So maybe this is one place where you could use a little help. You've come to the right place.
The Fool's very own Shannon Zimmerman has had years of experience in the mutual fund industry, and now he heads up our Champion Funds newsletter service. If you'd like to peek at Shannon's list of first-class fund recommendations, as well as fund manager interviews, discussion boards, and funds ("Duds") to avoid, a free guest pass is yours for the taking. Shannon's recommendations have beaten the market and relevant benchmarks, 20% to 9%, in the two years since the service began.
You can use mutual funds to enhance your existing income or savings. Start today with a free 30-day guest pass to Champion Funds.
This article was originally published on April 27, 2006. It has been updated.
Fool analyst Shruti Basavaraj bought an income booster from a late-night infomercial, but it didn't work. Shruti owns shares of Microsoft. Fannie Mae and Microsoft are Inside Value recommendations. Bank of America is an Income Investor pick. The Motley Fool'sdisclosure policy is a dream come true.