Yield conventions differ for stocks and bonds, but the various calculation methods for both asset classes have an important characteristic in common—they are alternative expressions of price. Measures of yield specifically relate current price to how much dividend or interest income holders of a particular security are likely to get. Thinking of yield as income itself is like thinking of a stock’s PE as its earnings. The latter is what you have an economic claim on as a shareholder and the former is an expression of how much you would currently pay to get it. So, if yield is the price of income, what do low yields tell us? Just as a high PE (low earnings yield) indicates that buying an earnings stream is relatively expensive, a low dividend yield (high price to dividend ratio) or yield to maturity tells us that buying income is relatively expensive.
Whatever its current price, income is what we live on in retirement, not yield. Chasing yield may stem from the old-school approach of living off bond coupons without invading principal. During higher interest rate regimes of past years, this approach seemed reasonable and may have worked for many. In 1980, 10-year Treasury rates exceeded 10% and were on their way to peaking over 15% in 1981. However, for several well-documented reasons, this strategy is generally less realistic today. First of all, the income “gap” that many people needed to fund with personal savings was, on average, probably lower then because income from guaranteed sources was generally higher. Not everyone had guaranteed pensions but many more did than today, and the Social Security retirement program was not jeopardized as it may (partially) be for future beneficiaries. Secondly, in the early 1980s, life expectancy of all 65-year-olds was about 16½ years. As of 2010, it was over 19 years. Many of today’s workers will need to fund longer retirements, of uncertain duration, with less guaranteed lifetime income. Longer lives shine light on another disadvantage of the coupon clipping strategy; it relies at least partially upon money illusion. Higher rates generally imply higher inflation expectations. Over shorter time periods, the compounding effect of inflation may be moderate, but with ever-longer funding horizons even modest inflation can significantly erode purchasing power.
Finally, as market interest rates change, a big disadvantage of chasing yield is that it may result in unintended shifts of underlying risk in order to maintain portfolio yield. As explained by Charles Schwab Investment Management, and covered in a recent PlanSponsor article, maintaining a given yield level implies adding credit risk when interest rates decline. Perhaps the worst part about relying on yield to fund retirement income is that one is beholden to market rates. Retirement income is too important to leave to chance.
Rather than chasing yield, or relying exclusively upon coupon interest and dividend payments for future income, many market participants could better prepare themselves for retirement by developing prudent withdrawal plans funded by accumulated savings. Withdrawal planning can take sources of guaranteed income into account such as pensions, annuities, bond holdings, and expected Social Security benefits, and it can also allow for maintenance of reasonable allocations to a diversified basket of growth assets.
 http://www.plansponsor.com/uncovering-hidden-risks-in-fixed-income-target-date-fund-allocations/?fullstory=trueThe posts on this blog are opinions, not advice. Please read our Disclaimers.