Do Higher Rates Mean Higher Income?

Since Jan.1, the yield on 10-year U.S. Treasury bonds (^TNX) has surged 40% to 2.58%. But do rising interest rates always translate into higher income? This is a common assumption, but it's not always necessarily true. Let's examine the yield income on two asset classes; stocks and bonds.

High Stock Prices, Lower YieldsIn early 2009, the S&P 500 (^GSPC) carried a dividend yield near 3.24%. The U.S. stock market (NYSEARCA:SPY) has since jumped 90, taking the S&P to 1,700. Today, the S&P's dividend yield is just 1.97% based upon estimated 12-month dividends as reported by Standard & Poor's. Put another way, the S&P 500's dividend yield is almost half what it was four years ago!

Long-term equity owners (NYSEARCA:DIA) have been rewarded with higher prices along with dividend income. However, for new buyers of stocks, higher stock prices have come at a serious cost; lower yields. This is especially true for retirees and yield focused investors who rely on a steady income stream.

Higher Yields and Portfolio DamageBond yields and bond prices (NYSEARCA:AGG) are inversely correlated. And although yields have been climbing, thereby producing more income for bond investors, those higher yields have been offset by losses in bond prices or principal. (Read: Rate Spike Causes $192 Billion in Losses at Federal Reserve) And if bond investors sell their bonds at lower prices, the potential to generate higher income on a lower sum of money is greatly impeded.

Erosion of IncomeAt today's 2.58% yield on 10-year Treasuries (NYSEARCA:IEF), you will still need to wait a long-time to double your money - 27.9 years - to be exact. And even then, you're still being scraped by taxes and inflation. WATCH: How Gold Experts are Misleading the Public

The current rate of inflation as measured by the CPI-U (all items) will steal almost 2% of your 2.58% yield. (See chart below) And if we correctly assume the government's method for calculating consumer inflation is understated, our 2.58% yield on 10-year Treasuries looks pretty bad. And if we include that taxes we have to pay on that 2.58% yield, clearly, higher rates haven't translated into higher income, because our real yield (or net) is now negative.

Building a long-term fortune, through both up and down markets, involves two simple steps:

1) Producing a sustainable income, and; 2) Protecting your principal.

Compared to history, we are still in a relatively low rate environment. This means that combating low yielding assets today requires a high powered approach.

For several years now, we've advocated an arsenal of both dividend income and premium income from call options. Since last August, our ETF Income Mix Portfolio has yielded 10.7% using a combination of dividend income and selling covered calls.

For investors new to options, you'll need to have your brokerage account approved to sell covered calls. You'll also need some basic education. I like the Options Industry Council's courses on the basics of covered calls. They also have other outstanding courses that cover various options strategies.