Bonds, REITs and the instant gratification of yield.

The message that inflation is eroding our wealth because the banks here offer such measly interest rates for our savings has become quite pervasive. 

I am sure that the message has been good for sales in some industries too as many more people are worried now. 

I know my parents talk about it a lot more these days.




So, what do people do? They go hunting for higher yields. One of the easier things to do is to go to the banks and invest in products which promise yields which are much higher than the said interest rates. 

Many also go to the stock market to look for stocks, bonds or preference shares which offer yields that beat inflation.

In the hunt for higher yields, we might want to keep this in mind:

"Always remind yourself that investing is a long term activity. So, avoid the instant gratification of yield... think carefully about how you are getting that yield... But there is a tendency in this environment for everybody to feel like 'I've got too much cash rotting in the bank, earning nothing, and I have to do something with it.' ... Don't just buy the highest yielding investment out there. Historically, that's how people get themselves into trouble."  - Tad Rivelle, CIO, fixed income, TCW.

Is the low interest rate environment we see the new normal? Won't interest rates go up again? Pause and ruminate on this for a bit.

When we are offered a high yielding investment, we should ask how the investment is delivering the promised yield and if it is sustainable. If sustainable, for how long is it sustainable? What is the likelihood of a capital loss at various entry prices?

I like how Tad said we should avoid "the instant gratification of yield". 

It sounds similar to how we should try delaying gratification in consumption as we try to build wealth.

By saying that we should avoid "the instant gratification of yield", Tad is probably suggesting that we could possibly get in at a lower price in future and get a higher yield then, everything else remaining equal. 

The suggestion that people who get in now could lose money as prices fall in future is there as well.

I don't know if Tad had a working crystal ball when he said what he said but I know I don't. Could the low interest rate environment persist? 

It could but with experts saying that interest rates could rise sometime next year, shouldn't people in long term and perpetual bonds be worried? 

What about people in interest rate sensitive investments like REITs?

If interest rates should rise, yes, these investors should be worried. However, the bond holders should have more to worry. Why? 

Well, if interest rates rise, it is probably because higher inflation demands it. 

Bonds are not businesses. They are IOUs issued by businesses. They only have to pay the agreed coupon and nothing more. 

Bonds tend to do badly in an inflationary environment as interest rates rise.

For REITs, we can reasonably expect their asking rents to increase in an inflationary environment. There will be constant adjustments made as cost of new debt becomes higher but as long as rents are lifted higher in tandem, there is really no issue, everything else remaining equal. 




So, when investing in a REIT, one of the things to look at is the possibility of higher asking rents in future which involves a whole gamut of considerations which mostly can be neatly sorted under two headings, "supply" and "demand".

When the Fed finally decides to raise interest rates, I am sure that market prices of yield instruments will take a hit just like they did middle of last year. 

How big a hit? 

I have no way of telling but I have an inkling that prices would in all likelihood overcompensate to the downside.

Depending on what our existing investments are, some will suffer more than others but chances of any investor escaping unscathed would be slim. 

So, now, do we liquidate all our investments and do a Chicken Little which is what some people have done?

Well, we could but knowing that I don't really know, my preferred method has always been to stay invested while maintaining a high level of liquidity. 

So, doing what I do means being able to continue receiving income from my investments which increases the level of liquidity that I have.

After all, what is the best way to ride out volatility? Having plenty of cash.




So, bonds or REITs, before we plonk in any money now, we might want to temper our expectations by reminding ourselves of the risk that comes with the instant gratification of yield.

Related posts:
1. Get paid more waiting for opportunities.
2. How to earn 6.3% interest after 4 years?
3. Nobody cares more about our money.
4. Never lose money in REITs or real estate?
5. Perpetual bonds: Good or bad?

When is it OK to be nice and unhappy?

Recently, I had a chat with a reader till about 1.30am in the morning. It was on the topic of insurance. Mind you, I wasn't giving any advice. I am not allowed to and I know it. We were just bouncing ideas off each other, she said, and she overheard me talking to myself.

In a recent blog post, I said that we often meet nice people in life and the reader I chatted with is a nice person and so is her husband. How could I tell?

Many of us are nice people who are considerate towards others. Unfortunately, nice people very often get taken advantage of in life. In the case of the reader, she had wanted to make adjustments to her insurance policies but her insurance agent had objected because:

"he said he'll have financial penalty if we withdraw some policies after buying 2 new ones this year from him"

So, what is the reader's plan?

"so, we decide next year, we'll be firm with what we think is right..at least he said within 1 year, if we terminate old policies after getting new policies, he suffers. So, next year, after the 1 year is over, we'll want to terminate some."

Isn't the reader being exceptionally nice? I think so. She really has no obligation to behave like this but she is being considerate despite being rather unhappy. I hope her agent appreciates it.

Personally, I had one such experience too when I bought an insurance policy when I first started life as a working adult. It was a whole life policy bought from a relative.

When the policy was delivered to me, it had riders which I didn't want (and I told him beforehand that if the product must be sold with the riders, I would not be interested) because it bumped up the premium by some 15% and it was a lot of money for a young working adult. He ignored my wishes because he needed the sale to hit some quota to qualify for some incentive trip.

I had wanted to cancel the policy but the relative objected and sought my dad's help. My dad told me not to cancel the policy because it would jeopardise the relative's career and I kept the policy despite being very unhappy. I lost all respect for that fellow (the relative, not my dad) since.

Nice!

Sometimes, it really doesn't pay to be nice, does it? To be nice, sometimes, we end up unhappy and paying more. So, how? Is it OK to be nice and unhappy? It depends.

We have to learn not to be nice and not care what some people think of us. Some people don't matter to us and, therefore, what they think of us should not matter at all.

Do you find it hard to tell who these people are? Well, if we know who are the people who matter, then, it becomes easier. The people who matter to me, ranked in order of importance:

1. Immediate family.

2. Close friends. Extended family.

3. Co-workers we work closely with.

4. Boss (whether we work closely with him or her does not matter.)

5. Friends less close. Co-workers less close.

So, anyone else should not matter much, if at all.

What should matter more to the golfer? The golf ball or the grass?

Over the years, I have become more discerning with requests for help and mindful about taking care of my own interests. There will always be people out there who would covertly or overtly try to take advantage of us. We should know this and beware.

There is still that boy scout in me but boy scouts grow up too.

Related posts:
1. To let go or to hold on to a position?
2. Nobody cares more about our money than we do.
3. Response from AK to accusations regarding seminar.