The Search for Income

Investors are once again having to scour the market for a source of income.  Whether they are looking to generate some return without a lot of risk to “beat the bank” CD rates, or supplement their retirement income, the search for yield to generate enough income has been difficult.  Based on current market conditions, investors must choose between safety with lower income or accept greater risk to achieve a similar income from prior years. 

To reflect this lack of income, the chart below reflects the 10-year US treasury rate going back to 1962.  Simply put, over the last 50 plus years, long term interest rates are at historical lows.  While this is great for spenders and borrowers (example: mortgage rates are at historical lows), this creates a dilemma for savers in the markets trying to live off their assets by generating income.    

This low level of income can also be seen through a variety of fixed income ETFs (below).  The data from State Street shows yield to worst (a good measure of yield if purchased today) for asset classes ranging from treasuries to high yield debt. 

As can be seen, long term treasuries (greater than 10 years to maturity) only provide 1.44% of annual income.  While treasuries are considered a safe asset class, long term treasuries still hold more risk of price decline due to interest rate rises.  The inverse relationship of bonds (as rates rise, bond prices fall, and vice versa) suggest that even a small rise in treasury rates could create a negative return in long term treasuries. 

Further, investors can achieve higher returns by taking on credit risk, or risk of a company defaulting on their debt.  This is reflected in the investment grade and high yield debt ETFs on the chart above.  Comparing intermediate investment grade to intermediate treasury gives investors a sense of the “spread” or premium for taking on credit risk.  You see that investors are receiving 0.89% premium annually (1.30% – 0.41% = 0.89%) but are still receiving significantly less than 2% in annual income. 

Lastly, high yield debt is paying 5.06% annually, which for many investors is a good amount of income for their portfolios.  However, high yield debt carries significantly more risk than treasuries or investment-grade bonds.  The chart below shows the performance of high yield bonds (blue) versus intermediate-term treasuries (black) and intermediate-term investment-grade debt (red).  High yield debt, during the downturn in March, was down over 20% while treasuries rose in value.  For investors who look to bonds for ballast in their portfolios, a full allocation to high yield debt is probably not going to provide that in times of stress. 

In closing, for investors, the choice is very much between safety with little to no income or higher risk to achieve prior levels of income from years past. 

At Gradient, safer portfolios include:

  • Stable value is a collection of very short maturity ETFs and money market mutual funds designed to provide safety and some income (though yield may be near zero for the foreseeable future).
  • Fixed income total return, which has 100% bonds but with a mixture of treasury, agency, and corporate debt.
  • Laddered income is split between investment grade and high yield debt at maturities that range from 2 to 5 years.

For investors willing to accept higher risk, potential Gradient options include:

  • The Absolute Yield delivers over 6% yield and does so via a mix of higher risk debt, high dividend stocks, and income-producing alternative assets.
  • The G50 and G40i are a collection of blue-chip stocks and both portfolios yield over 3%. When considering the dividend yield against a current treasury rate at 0.79%, combined with long term potential stock upside, the G50 is also an attractive option for investors willing to accept greater risk for their income needs.