Retirees don’t like spending down their savings.1 Unfortunately, it has never been more expensive to buy income from a portfolio. Historically low interest rates coupled with declining dividend yields has created a significant dilemma for income investors.

The average cost to generate $1,000 in income from a 50/50 balanced portfolio historically has been about $25,000. Today, $1,000 of income costs approximately $80,000 from a balanced portfolio and briefly exceeded $150,000 for bond investors in 2020. The rising cost of portfolio income is a global phenomenon.

In response to the low-yield environment, many investors will be tempted to reach for yield, either by purchasing lower quality bonds or equities with higher dividend yields. We demonstrate that these approaches will increase the risk of a portfolio with little expectation of reward through higher returns.

There is no easy answer for income investors whose expectations and behaviors need to be adjusted accordingly.

Living off yield

Yields on financial assets have plummeted. We document this effect for 10-year U.S. government bonds and large-cap equities from 1870 to 2020 below using data from Robert Shiller’s website.

Historical Yields

Source: Robert Shiller’s website

The average bond yield over the period was approximately 4.5% and the average dividend yield was 4.1%; at the end of 2020, these numbers stood at .9% and 1.6%, respectively.

What is most troublesome about the drop in yields is that they are taking place at the same time. Historically, periods of low dividend yields and or interest rates have cancelled themselves out some extent (i.e., when dividend yields were low, bond yields were high), and today both are well below long-term averages. Companies are increasingly using repurchases to return money to shareholders, which coupled with high equity valuations has decreased dividend yields globally, and bond yields have plummeted, in part from a flight to safety following the onset of the pandemic.