March 11, 2021
If you listen to some of the older population, either they or their parents talked about living off of dividends. It means that interest and dividends provided enough income to live on without touching principal. Those days have not been around for quite some time but below is an example looking at the world as it is today.
Tracking the 10-year government bond (a proxy for interest) and large companies (proxy for dividends) from 1870 – 2020, the average was 4.5% for government bond yields and dividends 4.1%.
For perspective, the last time the 10-year Treasury was over 4% was 2007. In 2000 it was 6.5%.
Today, these numbers are 0.9% and 1.6% respectively.
If you wanted to generate $1,000 of income (to live off of) you needed approximately $25,000 of a 50% bonds/50% equities to generate 4% income. As of January, to get $1,000 an investor needs almost $80,000 to accomplish the same income stream.
Investors will frequently reach for a higher yield by buying bonds of lower credit quality which by definition increases risk. Sometimes the investor doesn’t realize the additional risk being taken.
Another option, though most of us don’t like it, is to save more so there is more money to generate income. Perhaps your risk tolerance suggests having $80,000 with high quality credit ratings lets you sleep better at night rather than less money with higher risk because of poor credit quality.
At Financial Connections, we believe in diversifying a client’s bond holdings just as we believe in diversifying their equity holdings.