By Tim Courtney, Chief Investment Officer
In last week’s installment of our income series, we addressed where investors might turn for alternative sources of income in today’s environment. In this piece, we will wrap up the series by discussing the impact of the global income crisis on investments and how risks can be managed.
We have previously discussed the problem of low investment yields, many of them below the expected rate of inflation across the globe today. The 10-year Treasury yield, a rate upon which many other interest rates are based, is now only 1%.1 This is causing some investors to chase yield in niche areas of the fixed income and equity markets, producing portfolios that are far from diversified.
This problem isn’t going away anytime soon, with the Fed stating its intent to keep interest rates low until 2023.2 Governments also have every incentive to keep rates for savers and lenders low so interest costs remain small. Ironically though, low rates are causing problems for government pensions that now can’t generate enough return.3
Families who have saved and invested to produce a return that will cover future expenses are very much like these pensions. They have to determine what rate of return will allow them to meet their goals and then position their assets to be able to achieve that return. Unfortunately for many, this may now require taking on more risk.
Investors shouldn’t take on risks for which they are unlikely to be rewarded, and those risks that may provide adequate compensation should be managed. One way we manage risk is by constructing diversified portfolios made up of components that ideally won’t all behave the same way at the same time. In many cases, this does mean holding some amount of high-quality bonds with what are currently low yields. These bonds have tended to maintain steadier pricing when equity markets fall, like they did in 2000, 2008, 2018 and last year.4
However, other income assets (as we noted last week) can complement these bonds and provide diversification and potentially higher yields. These yields will come with risks that should be managed, but they may help an investor come closer to meeting their targeted rate of return. Those yields can be generated through a combination of interest, dividends, short-term capital gains, rent, etc.
Our base case is that we will see a gradual increase in rates as the global economy heals from the pandemic, but that rates will remain well below historical averages. As consumers, we should use the low-rate environment to our advantage. This could mean refinancing a mortgage or using low or no-cost loans rather than using cash for purchases.
As investors, low rates present a challenge. We are here to help you navigate this – please contact your Exencial advisor with any questions you may have.
Sources:
1. MarketWatch (1/29/21) – U.S. 10 Year Treasury Note
2. Forbes (9/16/20) – Federal Reserve says it will keep interest rates near zero until 2023
3. The New York Times (4/2/20) – Coronavirus is making the public pension crisis even worse
4. Yahoo! Finance (data as of 1/29/21) – S&P 500
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
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