Weekly Buzz: 💵 How to decide between stocks and bonds

Bonds are back. For years, income-seeking investors avoided the fixed income sector, with super-low interest rates keeping bond yields depressed. But tighter monetary policy since the end of 2021 – as central banks continue to battle inflation – has changed the game.

A question of yields

Even the most secure bonds now offer decent levels of income. The yield on 10-year US Treasuries now hover around the 4.5% level, and on short-dated UK gilts, yields are slightly higher at 4.6%. Many corporate bonds, issued by companies, offer significantly more.

Compared to equities, this level of income looks very attractive. The average stock in the UK’s FTSE 100 index of blue-chip shares offers a yield of around 4% (we break down yields in our Jargon Buster below).

So, should investors prioritising income now favour bonds instead of stocks? Well, there isn’t a straightforward answer. While bonds generally offer higher yields than shares, shares have historically provided increasing dividends and better capital growth prospects than bonds.

While yields on bonds vary over time, the cash value they pay – the coupon – does not. This is why bonds are known as fixed income investments.

Dividend payments on equities, by contrast, are not fixed – companies pay out what they feel they can afford to shareholders, depending on their performance in a given year. Many companies aim to increase dividends as regularly as possible.

For those with a longer-term horizon, and with inflation in mind, shares will likely remain an essential part of portfolio planning.

What’s the takeaway here?

For immediate income, bonds are now offering superior payouts to shares for the first time in many years. But looking at the medium or longer term, equities still offer better prospects for growth, which can protect the value of your income from inflation.

In practice, many investors will want to continue to own both equities and bonds, with a balanced portfolio offering risk mitigation and the potential to benefit from both investment classes. If you’re looking to invest in a balanced portfolio that diversifies across asset classes, you might want to consider our General Investing portfolios.

📰 In Other News

US earnings season is wrapping up – and it’s better than expected

Earnings season is almost done, and things don’t look too shabby. 82% of S&P 500 companies beat expectations, and it marks the first quarter of positive earnings growth after three quarters of declines. Pretty remarkable considering how some were predicting an earnings slump.

When you unpack the details of these results, you’ll see that a few mega-firms are really pulling their weight, like with Meta (communication services) and Amazon (consumer discretionary). But even if you took those two out of the equation, growth rates for those sectors would still be sitting pretty at 29% and 23%, respectively.

It’s been a worrying year for investors and businesses alike, with a recession that’s seemingly on the horizon. But when there’s trouble forecasted, companies tend to streamline, and cut costs where they can – battening down the hatches before a coming storm.

Later, after the storm passes, revenues start to roll in on a lower cost base. And if the expenses that were slashed earlier had been fixed costs, then those would become permanent cost savings, resulting in greater profits for businesses.

So think about it: the margin improvements that firms delivered this year will likely hang around into next year, and the year after that. That’s a very good thing for future growth.

This article was written in collaboration with Finimize.

🎓 Jargon Buster

Yield

Just as you earn an interest rate on your savings account, yield is the income you earn from any form of investment, expressed as a percentage. If you purchase bonds, yield depends on the coupons paid, divided by its current price. For stocks, it often refers to the dividends that companies pay out. So, if a stock is priced at $100 and pays a $3 dividend per year, the dividend yield is 3%. And when it comes to real estate, think of rental income.

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*The yield to maturity is provided by the fund manager and is not a guarantee for future returns. Yield as of 31 August 2023.