SOURCE: BMO Private Bank

BMO Private Bank

May 29, 2013 10:05 ET

BMO Private Bank: Explore Balanced Portfolio Strategies to Raise Income in Low Interest Rate Climate

PALM BEACH, FL--(Marketwired - May 29, 2013) - With the Federal Reserve committed to keeping interest rates at record lows through 2015, wise investors can take heart that there are effective strategies that can be implemented by wealth professionals to increase savings and even income from trust accounts during this low interest rate environment.

According to John A. Pavela, CFA, Vice President and Senior Portfolio Manager for BMO Private Bank, and John W. Tinnemeyer, Vice President, Director and Wealth Advisor for BMO Private Bank, there is good news for investors even in this low interest rate environment when the balanced approach to managing portfolios is put into place.

"We've been on the downslide with interest rates for over a decade now, whether you look at the yield to maturity on U.S. Treasury notes and bonds, or on high-quality corporate bonds or tax-exempt municipal bonds," reported Tinnemeyer. "During this period, yields ranged from 5.24 percent in December 2000, to a low of 1.39 percent in July 2012. As a result, overall disposable income has been impacted and those who want to maintain a quality lifestyle based on their savings and investments are wondering if that's even a possibility in this declining interest rate environment."

Trustees do have options to combat this low interest environment, added Pavela, who recommends that investors should not despair but inquire about implementing a balanced investment approach of stocks and bonds, with the goal of providing a reasonable level of income for the income beneficiary, as well as providing for principal growth for the remainder beneficiary.

While this might be impossible to alter if a portion of your assets is held in a trust for your benefit, there are options to explore if a primary financial component provides for the beneficiary's lifestyle, and the income deficit must be met from somewhere else. 

In cases where access to principal is permitted, this may result in additional requests being made by the income beneficiary to the trustee to distribute principal. These additional distributions may negatively impact the remainder beneficiary, especially if this low interest rate environment continues for an extended period of time.

An example of a balanced investment approach could be made with a $2 million trust invested 50 percent in a laddered portfolio of U.S. Treasury bonds with maturities between two and 10 years and 50 percent invested in the S&P 500 Index. At the end of December 2000, this hypothetical portfolio would have been generated estimated annual income of $64,700 or 3.24 percent, with $52,600 coming from the bond portfolio and $12,100 from the stock portfolio, which could be considered to be a reasonable return to an income beneficiary. 

That same type of portfolio would not look so attractive by today's standards. As of the end of August 2012, that same portfolio would hypothetically generate an estimated annual income of $27,440 or 1.37 percent. 

"The income deficit must be met from somewhere else, if this trust was a primary financial component in providing for the beneficiary's lifestyle," Pavela noted. "This may result in additional requests being made by the income beneficiary to the trustee to distribute principal, in cases where access to principal is permitted. If this low interest rate environment continues for an extended period of time, these additional distributions may negatively impact the remainder beneficiary."

According to Tinnemeyer, these issues can be combatted by the trustees. One option could be to explore additional types of investment strategies that could increase the level of income of the portfolio, including corporate, high yield and international bonds, and focusing on dividend paying equities. These strategies may result in an increased level of risk, so the trustee will need to balance the level of risk with the expected return. Provided that state laws and the governing document allow, there is another option to convert to a unitrust, allowing the trustee to provide for a periodic distribution to the income beneficiary calculated as a percentage of the portfolio value, as opposed to being determined by the specific investments held inside of the trust and the level of income being generated. 

This "total return" unitrust allows the trustee to balance the objectives of both sets of beneficiaries without having to change the underlying documents. It very well may be in the best interest to exploring one or both of the options listed above, as the Federal Open Market Committee (FOMC) statement "that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid 2015."

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Estate planning requires legal assistance which BMO Harris Bank N.A. and their affiliates do not provide. Please consult with your legal advisor.

About BMO Private Bank, a part of BMO Financial Group
BMO Private Bank offers a comprehensive range of wealth management services that include investment advisory, trust, banking and financial planning to meet the financial needs of high net worth clients. Through integrated teams of experienced financial professionals, BMO Private Bank helps its clients realize their financial and lifestyle goals with solutions that are custom tailored and delivered with the highest level of personalized service.

BMO Private Bank is a brand name used in the United States by BMO Harris Bank N.A. Member FDIC. Not all products and services are available in every state and/or location.

BMO and BMO Financial Group are trade names used by Bank of Montreal.

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