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Solution to Low Interest Rates

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Posted by Andrew Ruhland

on Friday, 14 October 2016 12:56

yield sign

Arithmetic is beautiful, elegant, and stunningly objective. Sometimes the truth of our own arithmetic is unpleasant…but if you can accurately identify the core problem to be solved, then you can get to work on actually solving it.

So let’s start with some typical retirement Arithmetic. If you need $50,000 of pre-tax income from your portfolio, at a 3% yield you need $1.67 million. At a 5.5% return (including current income AND capital gains), you need $909,090. The difference is significant, and affects when you can retire, or how much you can receive in retirement income.

Are you just going to sit back and take this “yield abuse” dished out on mature investors by Central Banks who’ve helped drive down interest rates, or recognize the problem and get it solved? Let’s get to work.

Having been indoctrinated for decades about how “safe” top-rated government bonds are, we find ourselves at or very near historic low yields, with lots of risk to your principal if you’re investing in long-term government debt. It’s happened before, at least a couple times in your grandparents’ lifetime. http://awealthofcommonsense.com/2015/03/the-blueprint-for-a-bond-bear-market/   The problem is real, the results are serious, only the timing is unknown.

As Jim Dines says, “Over-efforting creates countervailing forces,” so don’t ignore volatility of market prices simply because an investment has a high yield. Focus on total return, with yield (interest and dividends) as part of the overall return, along with prudent capital gains.

Below is a compilation of strategies for dealing with the low interest rate environment from the IWM stable of discretionary portfolio managers…not specific recommendations for the reader. All portfolios are managed within the framework of an Investment Policy Statement (IPS), which is a best practice among Fiduciaries. “Process provides protection,” and here’s an intelligent process:

  • Step 1: Seek Higher Yielding Fixed Income alternatives to Government Bonds, with a focus on credit quality, including:
  1. Corporate Bonds, preferably under 5 years to maturity to be able to reinvest at higher rates in the future
  2. Preferred Shares with a guaranteed floor-rate reset provisions, ideally at rates 3% or more > 10 year govt. bond yields…and tax efficiency
  3. Commercial Mortgages, with Loan:Value ratios > 75%, and
  4. Structured Real Estate Trusts
  • Step 2: Consider “higher than traditional” allocations to High-Yielding Equities. The old rules about no more than 30 or 40% equities in retirement are outdated. Consider the following:
  1. Blue-Chips are boring and effective. Utilities and other sectors like telecoms and consumer staples with stable cash flows and great dividend coverage are a start
  2. High Yielding Corporate Bonds behave more like Equities, so an ETF helps diversify away individual credit risk but not sector risk. HYG, JNK and XCB are a few well-known options that can fit the bill, but see notes on timing and currency below
  3. Alternatives like structured Asset-based Lending and Factoring pools yielding 6 to 8%
  • Step 3: Dynamic Strategies. Markets are fluid and dynamic, and management of your portfolio should be as well:
  1. Writing Covered Calls on your blue-chip equities to add 1 or 2% to your current yield
  2. Active Currency management, sometimes to grow but most importantly to protect
  3. Buy volatile assets like stocks and high-yielding corporate during pullbacks, not just because you have cash
  4. Think of cash as a tactical asset class, not a strategic one, unless you’re already drawing income during retirement
  5. Lock in gains with a disciplined risk management framework. Be one of the strong hands who are selling to the late-comer weak hands when valuations are stretched. You never go broke by taking a profit, and great assets can be bought back later at lower prices.

Increasing the yield within your portfolio almost always decreases its volatility, and the less volatile your portfolio is, the less likely you are to do something that is financially destructive like selling volatile assets near panic lows.

And remember, everything included in your Investment Plan should be consistent with the Life Goals ™ expressed in your Wealth Management Plan.

Andrew H. Ruhland, CFP, CIM

Founder and President, Integrated Wealth Management Inc. in Calgary


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