In 1986 the 10 year Treasury Bond was yielding nearly 10%. Six month CD rates were nearly as high. I remember a newly retired couple who had sold a successful business coming in to the Savings and Loan I was managing and opening up a CD and putting in the maximum amount that would be insured ($100,000 at the time) for a year at a rate of 10.25%. That CD produced $10,250 in interest for them during that year. Today, that same 1 year CD would provide $300 in interest during the one year term. That is a 97% drop in income over the past 30 years. Coupled with inflation and loss of purchasing power over that time, the now, much older retired couple would have likely used up their retirement savings, unless they changed their investment strategy and searched for other investments to improve their yield.

With the Fed keeping interest rates at near zero levels for almost 8 years now, finding yield has become harder and harder. Initially, investors like my couple above began moving from zero return CD’s into U.S. Treasury bonds. These instruments provided the security of being backed by the U.S. government and provided better yields than CD’s. But as more and more people sought out these investments, the price of these bonds kept getting higher and higher, making the total return you can get from these bonds unattractive. So, investors next looked at investment grade corporate bonds. No insurance or guarantees, but yields that were beating the returns on treasuries. Again, as more and more investors flocked to corporate bonds, the prices of these bonds became so high that the total return on the investment became very unattractive.

Low rated corporate bonds were the next instrument investors looked at for yield. These bonds offer no insurance or guarantees and are issued by less than credit quality companies. Once again, investors hungry for yield rushed in and prices went up, driving the total return potential to unattractive levels.

Now in the last 18 months or so, investors have gone to dividend paying stocks searching for yield. Again as more and more investors turned to these, the prices of these stocks have been driven up to levels that make them riskier to purchase.

In searching for yield, investors have increased the risk level of their investments each step along the way. Now people who are in dividend paying stocks are getting anywhere from 1% to 4% dividend returns on their money in an investment that traditionally has higher risk than treasuries and corporate bonds.

It will be interesting to see how these investors will react when their dividend paying stocks lose value during a market downturn. Will they hold, keeping in mind that they bought the stock for the dividend, or will they sell because they see a drop in principle, and go back to safer investments?

 

Mike Berry is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.

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