Higher
yields are available, but there’s a hitch.
After more than a decade and a half of well below average interest returns from fixed-income securities (most are bonds), the pendulum of interest rates is now swinging toward levels that had been considered “normal” over many decades in the past. Way back when, interest income from investment portfolios that had a substantial portion in bonds was often sufficient, combined with pension payments and Social Security benefits, to provide a comfortable lifestyle for folks in their later years.
Then came the banking crisis of 2007-9 and the Federal Reserve Board, this country’s central bank, plunged interest rates to historically low levels to keep the economy from collapsing. As rates fell, bond prices rose. Those who held bonds reaped hefty profits . . . if they sold prior to maturity. But people who depended on interest income came up short when trying to make ends meet.
Where to go now? There are a number of choices, none of which is best in class. They include long-maturity treasury bonds, long-maturity corporate bonds, high yield bonds, preferred stocks, and I bonds.
Long-maturity bonds, whether those of the U.S. Treasury or high-grade corporate issuers, are the most sensitive to changes in interest rates. The longer the time to maturity, the more their prices will drop when rates rise. The 30-year T bond now yields 3.25%. As rates rise, the current price of this bond will fall, which may more than offset the interest return. That’s equally true of high-grade corporates.
High yield bonds (a.k.a. junk bonds) now have average interest returns of about 8.5%. Seems interesting, but it’s important to keep in mind that these much lower quality holdings include an increased possibility of default, i.e., the issuer does not make the payments. The historical default rate for junk bonds was about 3.6%. Now it’s under 1.0%. Given that differential, junk bond investments seem like a roll of the dice.
Preferred stocks of quality companies appear to be less risky. Current yields from preferreds are about 6%, but here too there is substantial exposure to price erosion as the prevailing interest rate environment moves up. For the year to date, PFF, which is an exchange-traded fund that holds a number of preferred stocks, is off by 17%.
Last,
but not least, are I Bonds, which are issued by the U.S. Treasury. The good news is that the current interest
rate is 9.6%, which would be great if you could buy these in quantity, but
unfortunately there is a limit. You can
buy up to $10,000 in electronic I Bonds each year and up to $5,000 in paper I
Bonds using your federal tax refund (if you are entitled to one). More information is available at treasurydirect.gov.
N. Russell Wayne, CFP®
Sound Asset Management Inc.
Weston, CT 06883
203-222-9370
Any questions? Please contact me at nrwayne@soundasset.com
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