In this low interest rate environment, income recipients have been feeling the pain. We were approached last week by a client who is an income-only beneficiary of a trust. He was considering more yield-oriented investments to increase his income. We made the following points:
- This is a monthly chart of high quality corporate bond yields going back to 1919.
- All market interest rates have generally tracked it.
- Your bond portfolio yield, and thus your income, has followed the pattern.
- The last 12 months income levels have been the lowest since the late 1950s.
- You are not alone: US income recipients have seen their incomes hit very low levels.
- In percentage terms, the drop has been significant – 33% from pre-Credit Crisis levels.
- Recent circumstances have been very unusual – as demand for bonds has been abnormally high.
- Sources of this demand include fearful investors, banks needing riskless capital and the Fed’s efforts to stimulate growth.
- These sources of demand have pushed bond prices to unprecedented levels of overvaluation.
- Such extremes can tempt investors into counterproductive behavior.
- They can tempt them to act in a manner that is contrary to what a patient, total return-oriented investor should do.
- We expect current yields to eventually recover to more normal levels, with that 33% income drop being recouped over the next few years.
- June’s jump in yields took them back up to their lows of 2010, indicating the process has already started.
- Note the recent move in yield from 3.7% to 4.3% is an income increase of 16%.
- As abnormally high bond demand falls away, we expect this yield to eventually reach 5.5%.
- This will mean a significant increase in your income and the loss of windfall price gains of recent years.
- All income producing investments, whether they are marked-to-market or not, will behave like bonds and lose economic value when interest rates rise.
- We advise you to not add to bonds or seek higher yielding investments at this time. Your efforts would come at the expense of your portfolio strategy.
- Our approach is to always manage the portfolio from a total return perspective in the current and expected investment environments.
- We believe our approach will give you a high probability of growing income.
