Monetary Policy and Reaching for Income

Abstract

Using data on individual portfolio holdings and on mutual fund flows, we find that low interest rates lead to significantly higher demand for income-generating assets such as high-dividend stocks and high-yield bonds. We argue that this "reachingfor-income" phenomenon is driven by investors who follow the "living off income" rule-of-thumb. Our empirical analysis shows that this preference for current income affects both household portfolio choices and the prices of income-generating assets. In addition, we explore the implications of reaching for income for capital allocation and the effectiveness of monetary policy. AN ASSET'S TOTAL RETURN CAN be broken down into two components: current income and capital gains. Miller and Modigliani (1961) show that in frictionless capital markets, rational investors should be indifferent between these two sources of return. However, this core tenet of financial economics is at odds with a large body of popular retail investment advice that advocates living off the income stream from one's investment portfolio while keeping the principal untapped. 1 Investors who follow this "rule of thumb" structure their investment portfolio not only to maximize their risk-adjusted return but also to Kent Daniel is at Columbia Business School and the NBER. Lorenzo Garlappi is at the Sauder School of Business at the University of British Columbia. Kairong Xiao is at Columbia Business School. We appreciate the helpful comments and suggestions of Stefan Nagel (editor) and two anonymous referees, and those of Malcolm Baker (discussant), Bo Becker (discussant), Giovanni Gallipoli, Michael Gallmeyer (discussant), Mathias Kronlund (discussant), Yueran Ma (discussant),

The economic effects of real estate investors

“…This is consistent with the portfolio channel documented byDaniel et al (2021) for stock investments.…”

“…There has been a similar increase of investors’ activity during the pandemic. A related channel has been explored for financial investments (i.e., Campbell & Sigalov, 2022; Daniel et al., 2021; Martinez‐Miera & Repullo, 2017; Rodnyansky & Darmouni, 2017).…”

“…In a symmetrical way, the top-tier segment of the market is the top third of the price distribution in each MSA, and the top-tier price is the top 83rd percentile of prices within an MSA.9 These patterns suggest a portfolio channel as whatDaniel et al (2021) show for stock investments.…”

Dividend Restrictions and Search for Income

“…Taken together, our research extends the literature on search for income as a fundamental driver of trading decisions by some investors (see, for instance, Daniel et al, 2021;Harris et al, 2015; or Jiang and Sun, 2020). To the best of our knowledge, we are the first to uncover investor demand for income from a policy shock unrelated to managerial decisions.…”

The Heterogeneous Effects of U.S. Monetary Policy on Non-Bank Finance

“…Banegas et al (2022) find that there have been inflows to U.S. bond funds and outflows from equity funds after unexpected monetary tightening by the Fed. Daniel et al (2021) provide evidence for the U.S. that following an interest rate decrease, investors rebalance their portfolios towards assets that yield higher income, such as high yield bonds. Hau and Lai (2016) and Giuzio et al (2021) have similar findings in the Euro Area, while Kaufmann (2020) studies international flows and finds an increase in flows to investment funds globally after a loosening of U.S. monetary policy.…”