Investors living on bond income are getting squeezed badly.
Yields today on government bonds are so low that these investors, many of them retirees, simply cannot maintain their standard of living by relying on their current portfolios, especially when stock dividends are also falling. The temptation, with no improvement in sight for at least the next year or two, is to seek higher-yielding investments. However, this is often a big mistake, exposing retirees to unreasonable amounts of risk — with potentially catastrophic consequences.
Here’s what happened the last time we experienced a low-yield environment: Income investors decided to reach for yield instead of drawing down principal. In a world of 2 percent and 3 percent treasury yields, there are no totally safe ways to earn 6 percent or 7 percent. So, investors gave their money to “hard money lenders” and invested in principal-protected notes and other structured products. In 2006, these lenders were promising investors 12 percent cash yields. Today, they are falling into bankruptcy with the collapse of the real estate developers whose borrowing generated these investments.
Investors didn’t ask why it was a good idea to lend to people who had been turned down even by bank lenders who required little in the way of documentation. The structured notes issued by Lehman, for example, promised much of the upside of the stock market with principal protection, but instead they have turned into general creditor claims on a bankrupt, asset-less company.
Smarter Choices
The big question is this: What should investors do today to avoid the mistakes of the past?
The first, and most conservative approach, is simply to accept that for a period of perhaps two years, investors will need to withdraw principal to compensate for missing interest. This should not be seen as taboo. Principal might be depleted by 5 percent to 10 percent during this time, but that is much less than the losses that could easily be incurred by seeking higher returns at the cost of much greater risk.
The second approach is to take advantage of the incredibly depressed values of even high-quality assets that have been created by the panic selling waves of the last 18 months. It is too early to gamble on high-yield bonds, even though they are yielding more than 20 percent today, because we expect the economy to continue to deteriorate and corporate defaults to keep rising. However, investment-grade bonds are yielding considerably more than treasury securities.
This does add some additional risk, though not as much as the yield-chasing approaches outlined earlier. However, it offers the prospects of higher yield and ultimate capital gains as well. Specifically, we believe that investors can reasonably take a small part of a conservative bond portfolio and invest it in a well-diversified pool of AA-rated corporate bonds. Although the income would be taxable, the gain in yield would more than compensate for that. Note, though, that there will be ongoing ripples of volatility in this approach.
Either of these strategies is far superior to gambling on a 12 percent promise in a 3 percent world.
George Feiger is CEO of Contango Capital Advisors, Inc., the wealth management arm of Zions Bancorporation. The opinions expressed in this article are his and not necessarily those of Contango or Zions. Contango (www.contangoadvisors.com) offers an innovative approach to managing assets. It focuses on individuals’ real-life goals and uses sophisticated analytical techniques and risk-management tools to design clients’ investment portfolios. Contango is an entrepreneurial organization backed by one of the nation’s premier financial services companies.
Please note: Investment products and services offered through Contango Capital Advisors Inc., a registered investment adviser and a nonbank subsidiary of Zions Bancorporation, are NOT insured by the FDIC or any federal or state governmental agency, are NOT deposits or other obligations of, or guaranteed by, Zions Bancorporation or its affiliates and MAY be subject to investment risks, including the possible loss of principal value of amount invested.
Featured in the May/June 2009 issue of Zions Bank’s Community magazine.
*Artwork from ramsey everydaypants under Creative Commons license at Flickr.com.
Thanks for the article, timely and informative!
Let’s blame the right people. That is, the rating agencies of bonds specifically and of prefered stocks in general. Those ratings were incorrect and allowed even the most experienced investors to head down the path of destruction, even though many did proper do dilligence on their investments.
And, lets not forget those who sold the bonds. They too, had an obligation to be certain those ratings were “real”, and in fact they too looked the other way and kept earing comissions.
George-That’s “due” diligence.
And i agree with parts of all these diatribes, except that I would add there is real value in some equities and some real estate, depsite their current miserable price(s). Yet It is in the interests of the brokers/dealers of these tangible assets to trump, tout, and inflate their perceived value.
Our country needs to pay for what we need based on worth, not credit-worthiness, as it is all held by China and OPEC.
Interesting article. While I agree with most of it, I think what is missing is the big picture. And perhaps as a bank you cannot let onto the real issues with our money system. It is somewhat biased.
It refers to the last time interest rates were low, implying the 2003 thru 2005 era of just a few years ago. Well if we look at it for decades we see that the interest rate structure as a whole has been falling for 28 years. The minor ups and down is the modulating of the economy through the business cycle and has worked pretty well since WWII. It worked for the first decades because we were a manufacturing giant generating real wealth (not financial derivatives, CDO’s, MBS etc). It worked through the outsourcing years because there was room for interest rates to fall. What do you do when we near 0%? How can they stimulate the economy via lower rates? Game up? Who knows!
The problem now is that that policy doesn’t work because we’ve built a huge debt bubble in this country. It’s the type of scenario that peaks about once a lifetime. We are apt to see very low rates for quite awhile as the deleveraging and defaults work their way through the system.
If the government (and Fed) is careful with not piling on too much debt, this could be over in 5 to 10 years and then soft for another decade. If not, they risk a dollar crises and another economic depression. I personally think we’re headed for a disaster in a few years because of the way our money system works. That’s because it’s pure fiat currency where supply gets into the system via debt. (It’s loaned into existence). And thus it has a math problem. In other words to service prior debt with interest ever more amounts of money has to be created. The money supply is going to go exponential and nothing in this physical world can handle an exponential function without instability in that closed-loop system.
It’s a system that has been in place since 1913 and it’s probably coming to an end as nothing lasts forever.
All of you are pointing fingers at the symptoms of our economic situation. Here’s what everyone is missing on the economic issues that have plagued this country.
Thomas Jefferson, a giant among men, once prophesied that if we ever allow the creation of a Federal Reserve that can manipulate currency we were sunk. Before the Federal Reserve was created we had a cash-based society that correctly gauged the state of finances on a true production and demand society. Once the Feds could gain power and decide the value of our currency behind closed doors for whatever their vested interest reasons we, as a people, became susceptible to the foisting of credit and credit cards on the public with the misinformation that you can just charge whatever you want and as long as you can pay a minimum balance you could consider yourself solvent. So the public bit, was able to keep consuming beyond their needs and cash means, prices could then rise by the manufacturers of the goods and services to meet the artificial demands and voila! You have a society that is owned by creditors and for makers of goods and services they had to keep promoting more and more credit for consumers to continue to buy more and more to keep profits artificially inflated so a smaller percentage at the top, like AIG, ENRON, Hedge Fund investors, and the heads of corporations like Countrywide could make untold sums of money for corrupt business practices without shame. Add to that greedy politicians who have been elected and supported by strong unions and corporate giant favors to be self-serving rather than serve the productive public, not keep taxing the backbone of this country to feather their own nests and keep spending money to support those with a socialist view that the non-productive should be rewarded form the sweat of the honest working person’s brow, and you have what we do today. Add to that, the 16th Amendment that was supposed to only be a WWI temporary taxation, and now the government can bleed as much money out of the working populace as it wants with strong-arm tactics. The government does not earn money. It gets its money whether it provides good service or not, by taking it from the populace at will. And then you have what we do today. Finally, the ultimate demise of society rests on all shoulders of the general public that does not take the time to study the real issues. write to their local, state and federal politicians and demand proper government, a general populace that continually votes in Republicans and Democrats and believes the lies of sophisticated marketing machines to obfuscate the truth just ot get yet another vested interest professional politician elected from powerful interests to ensure they will still keep getting their excessive and selfish pieces of the pie. (I have studied the graft, who is in whose pocket and details of misspent tax money our civil servants enjoy. I am not generalizing.) 2010 is a critical year that begins the election process of our Congress. Keep in mind that it does not matter how many times Congress meets, or how long they debate or any special sesions,etc. they hold. The bottom line of anyone’s work is “what was the actual product?”If the product was a thriving society then re-elect these folks. If the product is a collapsed, imploding economy then I don’t care how many promises or haoe mny fingers are pointed, DON’T RE-ELECT THEM!!! If you produced thyis sort of debacle at your job you’d be fired. DON’T LISTEN TO THE SAME PARTY [LINE]!!! Let’s start looking at alternative parties for a change. Maybe these folks are not as slick as the polished political professionals. But they may have a lot more horse sense since they come from the working class and understand what the people want and the consequences of irresponsible government processes.
Some of you may not like the truth. But if you honestly look at how we, as a population, did not speak up, kept electing the same tainted parties, bought into the credit and greed, then we also have to take our fair share of the blame. If you are too busy to ensure your own freedom and do not give up a few nights in front of the TV to educate yourself and take aprt in keeping the legislation honest, then, well, we have what we, as a society, created.
Well said Leslee. Unfortunately our country is going the way that the people are taking it. Very few understand the fact that the founding fathers fought a central bank up until the Federal Reserve was founded in 1913. Our culture is becoming like the Romans where sports and celebrities are our idols. They don’t realize what is happening. Then they want more government to take care of them. It’s a pathetic situation that I see us falling into.
I personally feel that the bubbles and these wild gyrations in our economy are symptoms of the end days of this monetary policy…… fiat currency, fractional reserve banking, a debt based money system. It’s like a huge pyramid scheme. As the real wealth generating capability of our economy becomes ever more decimated, what is filling the vacuum is financial engineering. And we know that it does not create real wealth…..only illusions, bubbles, etc.