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High Rates are Good! Thumbnail

High Rates are Good!

 

Bonds

The table above shows why long-term investors are much better off now than they were at year-end 2021:   because their expected annual income is up so much, more than offsetting the drop in value.

At year-end 2021, a $1 million portfolio invested in the Bloomberg Barclays US Aggregate Bond Index had a yield of 1.76%. The annual income from that portfolio was $17,637 per year.

Interest rates have risen dramatically in 2022, driving down the value of bonds. That same $1 million bond portfolio was worth only $873,840 on November 30, 2022. That’s a drop in value of 12.62%!

However, the yield on the US Bond Index was 4.56% on November 30, 2022. So even though the portfolio was worth less, because the yield was so much higher the portfolio’s annual income was much higher:  $39,871 vs $17,637.

That’s well more than double what it was at the start of the year!


Stocks

Similarly, at year-end 2021, a $1 million portfolio invested in the S&P 500 Index had a dividend yield of 1.20%. The annual income from that portfolio was $12,047 per year.

The rise in interest rates during 2022 has driven down the prices of stocks. Future stock earnings and dividends are now being discounted at higher rates of interest, which mathematically reduces the current values of stocks. This effect is particularly strong for growth stocks which have more of their expected earnings and dividends in years further out into the future. That same $1 million stock portfolio was worth only $865,065 on November 30, 2022. That’s a drop in value of 13.49%!

However, the dividend yield on the US Stock Index was 1.55% on November 30, 2022. The higher dividend yield more than offset the lower value, so that the expected dividend income increased modestly, from $12,047 to $13,383.


Conclusion

Generating future income is the whole reason that we invest. Don’t let a short-term drop in portfolio values distract you from the long-term goal. As discussed more fully in “Funding Your Retirement Liabilities,” your portfolio now does a much better job of covering your expected retirement spending than was the case at the start of 2022. Rather than being discouraged by the drop in current values, you should be rejoicing over the higher income you will enjoy in retirement!