7 Years of Famine Hits Fixed Income Investors

by ETFguide | October 3, 2012 10:00 am

Overlooked in the media’s hyper-coverage of “QE3″ is the other part of the Federal Reserve’s big plans; the extension of zero-interest rate policy (ZIRP). Let’s look at how this is damaging income investors everywhere.

Today’s 7 Years of Famine

What’s happening to today’s income investor reminds me about the seven years of famine explained in the Bible book of Genesis. Back then, seven years of feasting were followed by seven years of famine, which extended through the ancient Middle East. What about today’s famine?

The Fed manipulated interest rates down to zero percent in 2008 and has kept them there ever since. And as Bernanke & Co. has reiterated, the Fed wants rates at zero until at least 2015. Put another way, 2008 to 2015 is the seven year period that equates to the Biblical seven years of famine for income investors.

Damage Assessment

How bad has it gotten? Let’s analyze the Fed’s damaging policies on income investors.

Investors with money parked in 10-year U.S. Treasuries (NYSE:IEF[1]) can double their money at today’s rate of 1.62% in approximately 44 years. Here’s some perspective: For 70-year olds reading this, that means you’ll need to extend your investment time horizon to age 114. You better eat your Wheaties!

The numbers are far more severe for investors with cash in money market funds (NASDAQ:FRTXX[2]). For today’s highest yielding 7-day money funds, you’ll need 720 years to double your money. (See table below) Annual yields at today’s money market rates of 0.51% will give you a double in 141 years. Even if you’re Methuselah, or someone in his likeness, it’s doubtful you have that sort of time or patience.

Inflation – the Sleeping Giant

“Over the past four years, the inflation rate has averaged a mere 1.2%,” argues John C. Williams, president and chief executive officer of the Federal Reserve Bank of San Francisco in his just published Economic Outlook. “That’s the lowest rate recorded over a four-year period since the early 1960s.”  Unfortunately, Mr. Williams’ exuberant tone doesn’t tell the whole story.

Although interest rates rise and fall throughout the decades, the erosion of the dollar’s (NYSE:UUP[3]) purchasing power has been nearly constant.  And the Fed has accelerated this phenomenon over the past five years with its multi-trillion dollar stimulus programs. By some estimates, the dollar’s buying power has declined more than 95% since 1913 — the year the Federal Reserve was born.

One solution for income investors is to choose higher yielding investments. The obvious problem is that many of these areas are jam packed with higher risks. So far this year, our Income Mix ETF Portfolio, has generated over $8,500 or 8.5% in annual income. There’s no magic formula, just a common sense approach of using low cost ETFs and not using leverage or chasing yield.

If income investors want to avoid another seven years of famine, balancing the need for yield with principal protection is an absolute must. 

How Long Does it Take to Double Your Money?

Investment Current Yield Years to Double Investment
Money Market (7-day) 0.10% 720
Money Market (annual) 0.51% 141
CD (5-yr) 1.38% 52
10-Yr Treasury 1.62% 44
Total US Bond Mkt Index 1.61% 44

Source: ETFguide.com


Endnotes:
  1. IEF: http://studio-5.financialcontent.com/investplace/quote?Symbol=IEF
  2. FRTXX: http://studio-5.financialcontent.com/investplace/quote?Symbol=FRTXX
  3. UUP: http://studio-5.financialcontent.com/investplace/quote?Symbol=UUP

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