Can interest rates get much lower? Those of you who were around during the late 1970’s and early 1980’s may have concluded that the current low rate situation is an anomaly . It is not . Click here for Exhibit A (also pictured below).
The aberration in interest rates occurred during the high rate period of the late 1970’s and early 1980’s.Those of us who are old enough to have taken out a mortgage during that period (including me) have a historical bias that is not valid. From this point in 2021 forward expect rates to stay lower for longer. The primary reason for this is that governments will do everything in their power to keep rates down. The US has approximately 27,000,000,000,000 in debt (more by the time you read this) plus another 1.9 trillion from the proposed stimulus bill currently being debated. A 1% rise in rates would add another 290 billion in interest payments.
Again, Governments will do everything in their power to keep rates low.
Some will say and have said that rates are artificially low. I tend to agree, but the reality is that rates are low and will likely remain low for a while. In light of this, as an investor, what can you do about the fixed income piece of your asset allocation ?
For those of you on the extreme low risk end of the spectrum, CD type investors , your choices are extremely limited . A recent quote from a major bank on a five-year CD was .60% . Translated into real dollars, this means that if you had 100,000 to invest, your annual interest income on the CD would be 600 dollars. It was not that many years ago you could get 2 or even 3 percent on the same CD. This represents a huge cut in a retiree’s income.
If you can bear to give up the absolute safety if a CD, here are some alternatives you can use to increase the yield on your fixed income portfolio:
- Short Term Corporate Bonds
- Short Duration High Yield
- Floating Rate Fixed Income
- US Government Securities
- And perhaps some Preferred Stock
Yields on these types of investments range from as little as 1% to as high as 5%. Unlike CD’s, there are no guarantees.
But 2.5 to 3.5 percent versus .60 percent is big.
You need to understand the additional risk these type investments entail as all of those above can and do fluctuate in value. The two types of risk we must evaluate in breaking away from CDS are interest rate risk and credit risk. Interest rate risk is the risk that securities will reprice according to a rise or fall in interest rates. CDs are also subject to interest rate risk, but the principal amount invested is guaranteed. As noted, it does not appear we can expect large interest rate increases over the next couple of years. Remember, when rates rise bond prices typically will decline. In contrast to bonds, the prices of Floating Rate fixed income investments, typically do not respond to declines in interest rates. However, those types of investments are subject to credit risk. Credit risk is the risk that the underlying borrower will fail to meet its payment obligation. Floating rate securities carry more credit risk than Investment grade bonds.
The bottom line is each type of fixed income investment comes with strengths and weaknesses. You will want help from your advisor in building your fixed income allocation.
Each of you will have a different risk tolerance, but sitting in cash and waiting for rates to rise, in most cases, is not advisable.
Many of you reading this newsletter already own many of the asset classes mentioned. We thank you for your business.
On an unrelated note , I would like to share my Mom’s favorite Marinade Recipe with you . She gave to me a couple of years before she died . Hope you can use and enjoy as much as I have .
1 1/2 cups of Canola
3/4 cup soy sauce
1/4 cup of Wooster
2 teaspoons of Dried Mustard
1 teaspoon of Salt
1 tablespoon of coarse black ground pepper
1/2 cup of Red Wine Vinegar
1 1/2 teaspoon of dried parsley flakes
2 cloves of Freshly Crushed Garlic
1/3 cup of Lemon Juice
Clyde Brooks Mosley, CPA