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 to 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 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 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 (VDIGX). Dividend-paying stocks are an excellent source of stable annual income, but individual stocks exposed you 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 Bank of America (NYSE:BAC), General Electric (NYSE:GE), Citigroup (NYSE:C), AIG (NYSE:AIG), and Altria (NYSE:MO).
With a beta of 0.88 against the S&P 500 index, you're getting less volatility in a fund that returned 12.5% per year over the past three years. All that with no load and an expense ratio of 0.37%, which is much lower than what you would pay for most funds in this category.
Management stability
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 those managers have enough confidence in the fund 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, look at the Dodge & Cox Income Fund (DODIX). This fixed-income fund invests in the corporate bonds of solid companies such as Xerox (NYSE:XRX) and high-rated mortgage-backed securities offered by Fannie Mae (NYSE:FNM) and others. It has returned more than 5.4% per year over the past five years, which beats its benchmark.
But another important part of stability is how long management has been part of a fund's performance. The Dodge & Cox fund's managers have been on board 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 relevant piece of information for mutual fund investors is whether a fund's managers "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, and most hold 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: 75% of all mutual funds underperform the market. That's a staggering statistic to consider 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 to avoid, a free guest pass is yours for the taking. Shannon's recommendations have beaten the market and relevant benchmarks 17% to 8%, 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. She owns no shares of any company mentioned above. Fannie Mae is an Inside Value recommendation. Bank of America is an Income Investor pick. The Motley Fool'sdisclosure policy is a dream come true.
