Income Investing Only Getting Harder
Low interest rates have made income investing harder than ever, but actions by central bankers threaten to make the problem for retirees even worse.
Earlier this month, the European Central Bank (ECB) slashed interest rates in a last-ditch attempt to stimulate the economy. To widen its effort, the ECB even added corporate bonds to the list of assets eligible for purchase under its quantitative easing program.
Traders reacted quickly. On Wednesday, corporate bond yields touched record lows in Europe. Several of the biggest listed companies in the eurozone recorded their lowest bond yields ever. (Source: “Corporate Bond Yields Touch Record Lows in Europe’s Periphery,” The Wall Street Journal, March 30, 2016.)
This week, the payout on telecom giant Telefonica’s January 2023 bonds dropped to 0.95%. By comparison, bondholders were earning as much as four percent from the same note in late 2013.
In June 2014, Ryanair June 2021 bonds yielded just over two percent. As recently as last month, the same securities were still yielding as high as 1.6%. On Tuesday, though, the payout on the Irish airliner’s note dropped to just 0.67%.
Corporate borrowing costs have plunged across the board. On Tuesday, the yield on the Bank of America Merrill Lynch’s Nonfinancial Bond Index for the Eurozone Periphery—which includes countries like Greece, Italy, Spain, and Ireland—dropped to 0.76%. This was the lowest level since the debt crisis of March 2015.
The news is bad for retirees.
For most people, their retirement math only works if they’re able to earn some interest on their savings. That’s tough given yields are so low. With bond portfolios earning zero instead of the four to five percent historical average, everyone from savers to pension funds and governments are struggling to meet their future withdrawal needs.
There could be other unintended consequences, too. Retirees will have to save more, which is a given. But many economists also worry low interest rates will encourage individuals, companies, and countries to take on more debt than they can afford, which could backfire if yields ever rise.
In search of returns, many people have been forced into riskier investments. That works great—until it doesn’t. Many income investors are learning a tough lesson in chasing yield, as evidenced by the recent collapse of master limited partnerships earlier this year.
While low bond yields are a European problem, Americans could be next. ZIRPs (zero interest rate policies) have given way to NIRPs (negative interest rate policies) in countries such as Japan, Denmark, and Switzerland. Federal Reserve Chair Janet Yellen has even discussed the idea publicly if the U.S. recovery begins to falter.
If the central bank is forced to act, retirees could be looking back on the days of positive interest rates fondly. Brace for another salvo in the ongoing war on savers.