A 1% World

Interest rates continue to fall. U.S. Treasury investments with maturities from one month to thirty years are now yielding below 2% as investors pursue safety. The Coronavirus is generating global economic uncertainty, and our government bonds are benefiting.

The ability to generate current income from bonds is challenging. In year’s past, you could rely on a steady stream of income from bonds to meet your needs. Bond interest, plus Social Security were usually enough for individuals to enjoy a comfortable retirement. In 1990, the yield on the 30-Year U.S. Treasury bond was 8%. If you needed $100,000 in income, you purchased $1.25 million worth of bonds. Today, you need $5.26 million, or four times as much. If rates drop to 1%, you’ll need $10 million to receive $100,000 in income!

With Interest rates at historic lows, where can you find income? Here are a few strategies you can employ today.

Dividend-Paying Stocks. Currently, 2,304 stocks are yielding more than a 30-year U.S. Treasury bond at 1.9%.[1] Johnson & Johnson, Intel, Coca-Cola, The Home Depot, Merck, McDonald’s, Pepsi, Lockheed Martin, Qualcomm, Target, Walgreens, and Clorox are some names on this list. Who knows what interest rates and the stock market will do over the next few days, but I’m confident the prices for most of these names will be higher in 30 years.

Systematic Withdrawal Plan: If you own mutual funds, a systematic withdrawal plan (SWP) allows you to generate monthly, quarterly, or annual income from your existing holdings. For example, if you invested $100,000 in the Vanguard S&P 500 Index Fund (VFINX) in 1980, 40 years ago, and withdrew 4% of the account balance each year, you received over $1 million in payments, and your account balance is now worth more than $1.5 million! In 1980, the income generated from this strategy was $4,000; this year, it will produce $62,956, an increase of 1,473%.[2]

Option Writing.  Writing options or selling calls on stocks you own is a great way to produce more income. Let’s say you own 1,000 shares of ABC company trading for $37 per share. If you want to sell your shares at $40, you can use a covered call strategy. A hypothetical option expiring in April may cost $1. You can write ten call contracts on your ABC holding because one contract equals 100 shares of stock. One thousand shares, or ten contracts, at $1 will generate $1,000 before fees and commissions. The $1,000 will credit your account when the trade is complete.  If ABC stock closes at $40 or higher on the April expiration, you must sell your stock at $40 regardless of how high it trades above your strike price. If ABC stock closes below $40 at expiration, you keep your shares, and you can write another ten contracts for May or June.[3]

Fixed Annuity. Normally, I’m not a fan of annuities, but desperate times call for drastic measures. A fixed annuity allows you to receive monthly income for a certain period, or the rest of your life. The annuity will enable you to receive the income generated from the investments, similar to a bond, or you can annuitize your investment and receive a guaranteed payout for life.  When you annuitize, you won’t be able to make any changes to your income stream. However, it will help you avoid longevity risk or the risk of outliving your money. An annuity is an insurance product, so your fees will be higher than most other products.

It’s tempting to chase rates, but do not be lured into a product offering an extremely high level of interest. A high yield may signal trouble with the underlying investment. Instead, as you hunt for yield, look for an investment that produces a consistent stream of income without taking on too much risk.

If you don’t find a way to make money while you sleep, you will work until you die. ~ Warren Buffett

February 24, 2020.

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

[1] YCharts

[2] Morningstar Office Hypothetical Tool, 01/01/1980 to 1/31/2020.  Your rate of return may vary and your results may differ. The hypothetical does not include fees or taxes which will adjust the results.

[3] Options involve risk and are not suitable for every investor.