Reaching for Yield

reachingIn its efforts to avoid deeper damage to the banks and economy in 2008, the Fed and the Treasury set the table for a decade (maybe more, if we’re lucky) of investors reaching for yield.

“Reaching for yield” refers to the process of moving money from one investment that was considered safer before, to another that has higher risk, but pays a higher rate of income. Directing trillions into mortgage backed securities and Treasury bonds after the Global Financial Crisis drove effective interest rates from those bonds down to levels we’ve never seen before, forcing millions of investors to move up the risk ladder to achieve the level of income they need to meet their objectives.

At points over the last few years there have been clear indications of a breakdown in the confidence investors have with the positions they’ve put themselves in by reaching as far as they have. For example, from July 2012 to December 2013, ten year Treasury yields went from what was then the all-time low of 1.46% to just over 3.0% after The Fed indicated they were considering a taper of their purchases in those MBS’s and Treasury Bonds. Now, I know 3.05% isn’t a high interest rate, but it’s over 100% more than 1.46%. And they hadn’t even actually done anything. More recently, the ten year Treasury yield again plumbed all time lows at 1.36%, but has risen to 1.8 within a few months. This could be attributed to a lot of different things, but it represents an increase of 32%. Only time will tell if this was the trend reversal point, or if there’s more to come.

I realize this is old news now, but I bring it up again because people keep saying things that tell me they don’t understand the long term implications this could have. I won’t delve into all the theories of what those implications might be here today, but what’s clear to me is that oceans of money have flowed into bonds over the last seven years, and the faintest whisper of a turn in that market could drive investors to back away from that over-reaching position in a big hurry.

So what’s this mean for you? Three things:

  1. Consider refinancing that home equity line of credit (the HELOC) to a thirty-year fixed-rate mortgage. HELOCs reset eventually and waiting for this to happen could result higher payments.
  2. Stop making extra mortgage payments! This doesn’t make you “safe”. Sure, it decreases the total interest you will pay the bank. But it also eliminates your ability to earn interest on that money forever.
  3. Instead of lending money for investment income, buy capital assets that will produce it. Yes, those assets will likely decline in value when this all unravels too, but if the asset is real, and I buy it with the expectation of holding it for twenty or more years, I’ll probably fare better during the storm than I would with a less tangible asset.

The herd will be culled when investors en masse retract from their reach for yield.