“More money has been lost reaching for yield than at the point of a gun.”
- Raymond DeVoe, Jr. (February 1995)
Investors may be very tempted to reach for yield in today’s low interest rate environment. Many people thought low rates were finally going to end when the Federal Reserve began to cut back Quantitative Easing III (QE3) in mid-2013. Even though QE3 ended in 2014, interest rates ended the year lower than when they began.
There is no shortage of headlines in the financial press instructing investors where they can find high-yield investment opportunities. I’m not going to debate the investment merits of the various strategies being touted for yield, except to remind you there is no such thing as a free lunch. Investments don’t pay 6% in a 2% environment unless risk is involved. If you don’t understand the risk or don’t think any risk exists, you should run the other way.
Investors chase yield by lowering the credit quality of their fixed income investments. BB rated junk bonds are yielding1 4.75% versus the 10-year Treasury note at 1.9%. They also chase yield by extending maturities. A 30-year treasury bond is yielding 2.7%, almost a full percent above the 10-year2. There are also income funds with creative strategies, preferred stocks, master limited partnerships, leveraged income funds, etc. all promising better yield for the income-starved investor.
My advice is to stop chasing yield.
A better overall strategy is to invest for total return. Fixed income is supposed to be your safe money. Your first priority for this part of your portfolio should be the safe return of your money, and secondly the return on your money. The other part of your portfolio should be growth oriented. Rebalance your portfolio to take advantage of market volatility and use the 4% rule to generate income.
Finally, add this rule to your investing handbook – never reach for yield.
1YCharts.com — US High Yield BB Effective Yield: March, 19, 2015.
2All yield data from YCharts.com