I was recently in a group where we were outlining discussion
topics for an upcoming conference.
Without fail someone knew someone would mention “generating income in
the low interest rate environment”.
I say without fail
because this is always, always, always brought up in settings like this. I will say however, the conversation has
evolved from “what will we do about impending hyperinflation and interest rates
rising 1000% overnight” to “how can retirees live off their portfolio income”.
That doesn't mean the conversation isn't worth having. It is and it’s very important. However, the one thing that always gets short
shrift in the conversation – risk – is equally important. The idea here is simple – want more yield? Take on more risk.
This is not to say taking on more risk in order to generate
more income isn't the correct decision.
It might be the case; however, the investor needs to realize that there
is no free lunch.
Further, given that rates are extremely low, I could argue
the risk is heightened as capital is misallocated. For example, negative yields on Treasury
bonds push more investors into High Yield bonds in a search for yield (remember
the extended low rates after Tech bubble).
This capital flow forces yields down, perhaps well below
their fair value. As a result, if/when
interest rates normalize and/or liquidity is less abundant capital could flow
the opposite direction, which would force up interest rates on higher yielding
assets and lower their value.
I’d like to remind you, this is not a comment on what assets
an investor should hold or where interest rates will go, but rather a general
discussion about simply this fact: if you want to generate more yield, be sure
you realize you are very likely taking on more risk.
