What Are These Yields Telling Us?

LT Site Icon

Something is happening in the financial markets that has never happened before. Yields on 30-year Treasury bonds are lower than the yield of the S&P 500. What does this mean? Essentially, the risk-reward payoff is overly skewed in favour of equities not only due to their ability to hold value against inflation, but also because of their ability to generate dividend income.


Equity vs. Fixed Income Oversimplified

Investing in common equities traditionally has two benefits: 

1) Capital gains, which arise as the value of your stock holdings increase over time.
2) Dividends, which come in the form of periodic payments from the company to shareholders. Essentially profit sharing with shareholders. 

Investing in fixed income on the other hand typically has the sole benefit of receiving a pre-specified amount in the form of an interest payment or coupon. Fixed income investors do not get the benefit of capital gains.


Low Interest Rates Make Fixed Income a Tough Sell

In order to compensate fixed income investors properly when purchasing an investment that doesn’t offer the opportunity of capital gains, a higher yield or nominal rate is typically required. This however is not the case right now thanks to the low interest rate environment. The result is below average nominal returns on traditionally safe fixed income investments as well as zero chance of investment growth in the form of capital gains… Thats a pretty tough sell even before factoring in taxes and inflation. 

As of Nov 3, 2020: 
30-Year Treasury Yield = 1.55% (Source: CNBC)
S&P 500 Dividend Yield = 1.80% (Source: Ycharts)

30-Year Treasury Yield Since 1986
Source: CNBC 30-Year Treasury Yield Since 1986


Understanding Real Rate Of Return

The real rate of return is the annual percentage of profit earned on an investment, adjusted for inflation. Adjusting the nominal return to compensate for inflation allows investors to get an accurate picture of how their wealth or purchasing power changes over time. The formula for real rate of return is:

Real rate of return = nominal return – inflation rate

Similar to how taxes chip away at your earnings, so does inflation. The long-term inflation target in Canada, as well as the US, is around 2% per year. Say you were to purchase a 30-year US government Treasury bond today with a yield of 1.55%. Assuming the inflation target of 2% per year actually materializes, your real rate of return would be -0.45% per year. Contrast this with a hypothetical investment in an equity that grows by approximately 4% per year and generates a 1.8% annual dividend. Factoring in inflation, your total real return would be: 

(Growth Rate) + (Dividend) – (Inflation) = (4%) + (1.8%) – (2%) = + 3.8%

+3.8% is a heck of a lot better than -0.45%, especially when compounded over the span of 30 years. Needless to say, it is absolutely critical to have a solid understanding of real returns prior to making any investment decisions. 

Financial Advice is Crucial

Times are tough, and there is a lot of uncertainty in the markets right now. If you or someone you know are in need of financial advice, we are always happy to chat. We don’t charge for the first consultation, and there is no obligation to sign-up. Contact us to book a free financial consultation with one of our licensed financial advisors. 

Alternatively, you can read more about investment yields and interest rates by filling out the form below. 

Read The Full Commentary

If you do not have access to our monthly email, you can request it here:

Your privacy is fully protected. By filling out this form to request this month’s commentary, you give explicit permission for LT Wealth Management Partners to email you to deliver our e-newsletter. It is important to note that your consent acknowledges agreeing to receive our newsletter knowing that your name and email may be stored on external servers outside of Canada. 

Share on facebook
Share on twitter
Share on linkedin
Share on email

Looking to build sustainable, long-term wealth?

We can help.

(604) - 416 - 2505


555 Burrard St, Vancouver BC

Article Disclaimer:

Links provided to other internet sites are for the convenience of users. Raymond James Ltd. is not responsible for the availability or content of these external sites, nor does Raymond James Ltd. endorse, warrant or guarantee the products, services or information described or offered at these other sites. Users cannot assume that the external sites will abide by the same Privacy Policy which Raymond James Ltd. adheres to. Information in this article is from sources believed to be reliable, however, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of LT Wealth Management Partners and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision.