Yield chasers may not be as crazy as we think. From the standpoint of modern portfolio theory, investing in asset classes with elevated yields is suboptimal (meaning, crazy). Portfolios focused on yield don’t diversify the allocation as well as more diversified portfolios. This leaves the client exposed to a series of avoidable risks:

  • Interest rate risk: Securities with high yields are more sensitive to changes in interest rates.
  • Sector risk: Higher yields are found more often in utilities and REITs, while less frequently in technology.
  • Liquidity risk: Income portfolios shy away from liquid Treasury bonds and favor less liquid corporate bonds.

The net effect is a portfolio with extra risk for an investor whose objective is steady income. It seems like a dangerous match for the many retirees who use this strategy.

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