A question regarding "stretching for yield"

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A question regarding "stretching for yield"

Postby arcticpineapplecorp. » Sat Mar 23, 2013 2:42 pm

A family member called me the other day asking for help/ideas to invest some of the money he has in savings because it's earning so little in interest there. He is in his 40's, so I see that the problem of "stretching for yield" is not one that is confined to those on fixed income (i.e., those in retirement/elderly, etc).

It got me thinking about the "stretching for yield" concept. I understand this is occurring because less risky assets (like savings) are earning so little, but isn't the rate of interest earned on savings usually less than the inflation rate anyway (except in deflationary times)? Because of this, then doesn't money in savings always fall short because of inflation?

Another way of saying this is, "what does it matter whether interest rates are close to zero or double digits (like in the 80's)?" Didn't savings, while earning double digits in the 80's still not buy enough because inflation was still higher than interest rates? Or at some point were interest rates actually higher than inflation rates once Volker started choking it off?

I was too young to remember what happened in the 80's, but my understanding of savings is that because it is free of risk (except inflation risk), that is why there is such low compensation in the form of low interest earned. Any info is appreciated. Thanks.
Last edited by arcticpineapplecorp. on Sat Mar 23, 2013 5:47 pm, edited 1 time in total.
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Re: A question regarding "stretching for yield"

Postby jebmke » Sat Mar 23, 2013 4:42 pm

People tend to think in nominal terms. When short term rates were high in the 80's people didn't think in real terms very much. When nominal rates are low, there is an illusion that you are necessarily worse off than when nominal rates are high.
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Re: A question regarding "stretching for yield"

Postby nisiprius » Sat Mar 23, 2013 5:10 pm

I think that the real rate of return on low-risk investments really has fallen.

You can see this clearly in the coupon rate for TIPS and the "fixed rate" for series I savings bonds, both of which were in the neighborhood of 3% a decade ago, and both of which are in the neighborhood of 0% today.

So, there are three possible responses to this.

a) Grin and bear it. Nobody ever promised you a rose garden.

b) Knowingly take on more risk in order to get return, having thought carefully about the nature of that risk and deciding that you really are OK with it. In my case, for example, there's a decent chunk of change that used to be in Vanguard Prime Money Market that I thought of as part of our "emergency reserves," and I think I've convince myself that we probably won't need to tap it on short notice and it's OK to put it in Short-Term Bond Index, and if it happens to be 1% down when we need to draw on it, so be it.

c) Not being willing to take on more risk, but kidding oneself that one has found a higher-yielding investment that doesn't have higher risk.

Responses (a) and (b) are OK, response (c) is not.
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Re: A question regarding "stretching for yield"

Postby tibbitts » Sat Mar 23, 2013 5:15 pm

I'm definitely not too young to remember the 1980s. And thankfully, not too old yet, either! I can only speak for myself, but the personal inflation I experienced in the 1980s was far less than the inflation I experience now. For example, throughout the 1980s my rent, including utilities, rose a total of 0%. Now my real estate taxes essentially increase the maximum-allowed-by-law 5% annually (although a change in the law may limit those increases to "only" 3% in future years.) In the 1980s, my salary increased every year through cola adjustments, promotions, and merit increases. Now, my salary is lower in inflation-adjusted terms than it was then, and has remained the same (even in nominal terms - no cola) for several years.

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Re: A question regarding "stretching for yield"

Postby nedsaid » Sat Mar 23, 2013 9:25 pm

This is why you have to think in terms of purchasing power versus nominal dollars. Safe investments might actually only guarantee a loss of purchasing power.
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Re: A question regarding "stretching for yield"

Postby tibbitts » Sun Mar 24, 2013 8:42 am

nedsaid wrote:This is why you have to think in terms of purchasing power versus nominal dollars. Safe investments might actually only guarantee a loss of purchasing power.

Very true, but I think the OP's point was that there have been prolonged periods during which some of us enjoyes "safe" investments that didn't seemingly guarantee a loss of purchasing power. Today we have a situation where "safe" investments are very likely (but not certain) to result in significant loss of practical purchasing power. So the only choice for many is to increase risk.

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Re: A question regarding "stretching for yield"

Postby dickenjb » Sun Mar 24, 2013 9:08 am

Actually if you look at Ibbotson data from 1926 the risk free rate (T bills) is usually small and positive in real terms. Albeit smaller than bonds and smaller still than stocks.

Today it is negative.

But I also agree that naive investors look only at nominal rates and aren't sophisticated enough to think in terms of real rates.

The other day we had a poster hoping for more inflation so that nominal rates on I bonds would go up. :confused

In any case, today we have very low rates in nominal terms and negative in real terms.

So both naive and sophisticated investors are not happy with their fixed investments.

I think you suck it up and remember that the primary purpose of fixed income is not earning the coupon.

It is keeping a part of the portfolio safe and reducing overall portfolio volatility to an acceptable level.
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