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The Dangers of Chasing Yield

By on March 4, 2013
Categories: RETIREMENT

Millions of retirees around the world are diligently searching for yield.

If you are one of them, you already know that it’s very hard to find.

The yield on the one-month U.S. Treasury bill was recently measured at the barely perceptible rate of .09%. Last summer, the yield on the 10-year U.S. Treasury bond hit an historic low of 1.43%.

With the disappointing low rates of relatively-safe Treasuries, investors have been hunting in risky places for income. Money is gushing into emerging market and global bonds, high-yield (or “junk”) bonds, and fixed-income mutual funds and exchange-traded funds of all maturities.

Many investors assume that any kind of bond must be safer than stocks, but that is a dangerous assumption to make when allocating assets to bonds in a diversified portfolio.

High-risk bonds can behave like stocks.

What investors don’t always appreciate is that there is a reason why some bonds look more tantalizing. These bond issuers need to fatten up their yields to compensate investors for greater credit risk or longer maturity dates.

After all, the credit risk for a country with high political risk or a company with a weak balance sheet is going to be much higher than U.S. Treasuries, which have historically enjoyed the moniker of being free of credit risk.

Because of their risk profile, high-yield bonds often end up behaving like stocks during turbulent times.

You can see this relationship  in the table below from a 2013 white paper published by the Vanguard Group that shows returns during the global financial crisis from October 2007 to March 2009.

In the above example, only Treasury bonds fared well during the market meltdown as investors bid up their prices.

Bottom Line:

Chasing yield is a dangerous pursuit.  Including a significant allocation to high-yield or longer maturity bonds in a portfolio can significantly increase its volatility.

A portfolio’s total risk profile and expected total return, not the current income that it spins off, should be what investors are looking at when they are assembling a mix of assets that can support a sustainable spending rate in retirement.

If you want to learn more, here is one of our previous posts that talks about this type of investing:

Let’s Hear It For Total-Return Investing

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