The need for income

November 03, 2010

In today’s low yield investment environment, building a portfolio to generate cash for consumption is a challenge portfolio managers have not experienced since the 1950s. As a result, “I need income” may be the three most prevalent words heard from clients.

What makes investing for income so difficult today is that bond yields right across the board are at record low levels. In a desire to stimulate economic growth, central banks around the world (dominated by the US Fed) have pushed interest rates to what is effectively “zero.” As a borrower, this is a good thing; as a saver, it is horrific.

Investing used to be more straightforward. The safest investment was a T-bill, with a yield generally approximating the inflation rate. If a higher yield was needed, a government bond with an increasing maturity was bought, because the longer the maturity (the greater the possible risk from inflation), the higher the yield. If an even higher yield was needed, an investor would buy a corporate issue bond and take the added risk of default in addition to inflation. If an investor was more interested in the “bird-in-the-bush,” equities were purchased, which generally paid a lesser yield than a debt instrument, but offered the potential of a higher return through capital appreciation.