Investing in a Low Yield World, What Are We Doing?
As you no doubt know, we are operating in a low yield investing environment. In the U.S., the Federal Reserve cut the discount rate (rate at which banks lend to each other) to 0% back in 2008 and we haven’t gotten above 2.5% since then. While the Fed started increasing rates between Dec 2015 and Dec 2018 (up to 2.5%), they didn’t manage to get back to a more “normalized” level before having to start cutting again. Now investors expect another 1 to 2 rate cuts by the end of the year. The Fed has done a complete U-turn on trying to raise interest rates.
Meanwhile, if we look internationally, we have now surpassed over $13 Trillion (yes, with a T!) of negative interest rate bonds. About 25% of global bond exposure has negative yields! Investors who end up buying these bonds and holding to maturity will end up getting less money back than they paid, even including interest. Completely opposite of what we expect bonds to do in our portfolios. Even Greece (a country that has had more than one bail out to stay afloat) is now being paid to borrow money – that’s essentially what the negative interest rates imply!
Why is this happening? Short answer, there are not enough “safe” assets to go around. A low-risk asset is especially attractive when markets feel uncertain, like now when investors fear either a recession or trade war that will crash the stock market. There is a big demand for low risk assets but not enough of them to go around, not enough supply. This keeps yield low and now negative. The longer answer has to do with demographics, low inflation and low growth globally.
What does this mean for us as investors?
Back in the ‘90s, it was reasonable to expect a 7.5% annualized total return with a very low risk level. Now, to have the chance at a 7.5% annualized expected return, we have to look at more asset classes, more types of investments, and a much higher risk appetite to have the chance at a similar type of return. This chart below shows the same expected return for each portfolio but a much different risk profile and set of riskier assets in the portfolio to achieve that same return. (Risk is measured by standard deviation in the chart below.) Whereas maybe a portfolio of steady fixed income bonds could achieve that 7.5% rate, now we have to look at different types of stocks, here and abroad, along with other alternative investments.
This chart gives you a sense of historical Treasury rates. How much yield/income could you get by investing in safe, government issued treasury bonds? Back in the ‘80s, you could average about $114,000 annually just by being invested in safe assets. This past year, you would end up with about $22,000 if you had that same, safe portfolio.
So, what are we doing?
We have to get creative and look for other ways to earn a consistent yield which is the key to our investing process – trying to aim for consistent returns.
We are in a low yield environment and we know we have to take on more risk in portfolios to earn reasonable rates of return. We also know that we are in late stages of the economic cycle and we have to be cautious in portfolios. The main things we are doing in the portfolios are; 1. Staying cautious and diversified 2. Improving quality in types of stocks and bonds we own in portfolios and 3. Looking at unique structures and alternative assets to invest in the portfolios.
Written by Sevasti Balafas
GoalVest Advisory LLC
V Wealth Advisors Investment Management Partner