As an investor, you need to adopt a Yin Yang Investor Mindset. In other words, always recognize that whenever one asset class is booming, another asset class may be suffering. If you feel like you missed the boat with one investment, just know there’s another boat somewhere in the world waiting.
My investment mindset as a retiree since 2012 has always been to protect principal first. Losing principal when you no longer have a day job is a terrible thing. But at the same time, back then I felt we were in the middle of a potentially strong recovery so I had to invest in equities.
The solution: I invested in plain vanilla S&P 500 and Dow Jones structured notes with downside protection. In return, I’d forego some or all of the annual dividend.
Unlike some retirees, I wasn’t focused on generating income from my investments because I had enough to live on largely through rental income and a growing online business. In a bull market, you want to invest in principal growth to maximize returns. But now, I’ve slowed down my additional equity investments and am now focused on bonds because they are finally selling off.
Why Are Interest Rates Rising?
Take a look at this chart of the 10-year yield post Donald’s victory. The rate increase looks like an internet stock from 2000!
Why did the 10-year bond yield jump by over 20 basis points in one day? The reasons are Donald plans to cut taxes, increase infrastructure spending, and throw up 35%-45% tariffs for imported goods, which will increase the federal budget deficit and increase inflation.
Whenever there’s higher expected inflation, rates go up to counteract increased monetary demand. Further, investors tend to sell existing lower yielding investments in favor of higher yielding investments until there’s market equilibrium.
Who gets hurt when interest rates go up:
* Bond holders
* REIT holders
* Potential homebuyers due to higher borrowing costs
* Home sellers during the initial interest rate ramp
* Borrowers with variable rate loans
* Future borrowers
Here’s who benefits:
* Cash rich investors looking for income generating assets
* Retirees who depend on income generating assets
* Homeowners over the longer term who see their property values inflate with inflation
* Equity investors if higher inflation expectations is a harbinger for higher earnings
* Lenders – just look at bank stocks
There’s always an adjustment period that happens during any large interest rate jump. Investments move quickly, but the repercussions of such moves take time to play out.
Take a look at the California Municipal Bond (CMF) below. This is a security I’ve been eyeing as interest rates were starting to slowly creep higher pre-election. I’ve been looking at double tax free securities since I’ve run out of legitimate business expenses to lower my taxable income. I also thought Hillary was going to win, thereby keeping the status quo of higher taxes.
CMF has declined about 5.8% from its recent peak to now $116.83 after interest rates ramped post election. At $116.83, CMF provides a ~2.6% double tax-free yield for California residents. As I stated in a previous post, my trigger point for aggressively buying bonds is when the 10-year yield hits 2%. Now that we busted past 2%, I’ve started the process of more aggressively building my bond portfolio and have deployed roughly 60% of my planned allocation.
I plan to slowly deploy the remaining allocation the higher the 10-year bond yield goes. I believe the short-term 10-year yield interest rate cap is 2.5%. If we get to 2.5%, then I’ll allocate 100% of my funds and then work to rebuild my cash hoard again.
Everybody needs to come up with their own investment game plan in order to stay disciplined. Structure an investment outlook that makes sense to you. Or, you can just have a digital wealth advisor manage your money.
Note: Other attractive investment opportunities I’m looking at that have sold off post election include MUB, AGG, and OHI.
Focus On The Positives
You can focus on the negatives of higher interest rates or you can be opportunistic. The opportunist in me sees a scenario where I can finally build a sizable bond portfolio so I can continue enjoying the fruits of early retirement. Focusing on the positives will not only make you happier, it should also make you wealthier as well.
My original plan was to try and work as much as possible to take advantage of a potential three year or longer window of lower taxes. But honestly, it was a little depressing thinking about having to commute in rush hour traffic again. And for what? To attend a meeting to hear an insecure colleague fluff his feathers? That’s terrible.
But now that rates have moved higher, I’m coming around to the fact that maybe full-time work is no longer necessary. What a goldilocks scenario where stocks AND yields move higher. I’ve been somewhat dreading the expiration of my 3% – 4% yielding CDs starting in 2017. But if I can now earn a relatively low risk 2.5% double taxation free dividend yield, that equates to a ~3.7% – 5.3% pre-tax yield, depending on your type of investment and tax rate. Asset allocation solution achieved.
The key to building passive income has always been to amass enough capital to generate a livable income stream in order to never have to work again. That’s hard to do in a super low interest rate environment. Now that interest rates have moved higher, there’s no need to save as much to produce the same amount of income.
Instead of $3,625,000 of capital required to generate $50,000 a year from a 10-year bond earlier this year, you only need $2,358,000 today. What a wonderful thing! That’s positive thinking my friends.
Wealth Building Recommendation
Manage Your Money In One Place: Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. You can use Personal Capital to help monitor illegal use of your credit cards and other accounts with their tracking software. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing. I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.
Readers, do you have the Yin Yang Investor mindset? What are some other Yin Yang investor mindset examples you can think of? Are you looking at the bright side of higher interest rates by taking advantage of the bond market sell-off and looking to become a lender in instruments such as P2P, real estate crowdsourcing, and hard lending? I’m seriously looking at doing all these things more aggressively now.
Yin Yang definition: In Chinese philosophy and religion, two principles, one negative, dark, and feminine (yin) and one positive, bright, and masculine (yang) whose interaction influences the destinies of creatures and things.
Updated for 2019 and beyond. Rates are closer to 3.25% on the 10-year bond yield, and 30-year fixed mortgage rates are closer to 5% now. Real estate is really beginning to slow on the coasts. I’d invest in the heartland of America instead with Fundrise.