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May 4, 2016

Where can I still find 3% yield with bonds?

What yields are currently availabe for investors in the fixed income market? We provide a brief overview how bond markets have changed over the last few years and what options investors still have who are looking for a minimum yield of 3%. While 3% might have seemed barely attractive a few years back, we need to sound a note of caution: anything above 3% now carries a risk of loss of principal. In most cases, the fixed income portion of your portfolio should be for safety while growth comes from the equity portion. Do not try to overstretch for yield.

You have come a long way, baby

In 2000, investors could easily generate a 5% yield from the safe government bond portion of their portfolio. Yield-hungry investors who were willing to endure higher volatilty found a rich hunting ground with EU and US High Yield corporate bonds yielding around 15%. Only Japanese government bonds yielded less than 3%. These figures are nominal, i.e. before adjusting for inflation, but even in real terms, they were higher than what we can get today.


In 2016, the picture has changed dramatically. There are no safe government bonds yielding even anywhere close to 3%. At the end of March 2016, 38% of all government bonds of developed market countries traded at negative yields! As we can see from the chart above, yields for most areas of the fixed income markets have compressed significantly and are now between 0% and 3%. It is important to point out that investors trying to stretch beyond 3% have to enter exotic markets such as local currency emerging market debt. We keep repeating ourselves but investing with yields above 3% today means putting your principal at risk!

Yields are lower but risks are higher

Today’s bond environment is not just lower yielding but also riskier. What do we mean by that? Duration (the measure of how much bond prices are likely to change in response to changing interest rates) has increased dramatically in every market. In simpler terms: investors are taking on greater price sensitivity for lower yields. Policy missteps by the central banks will have a huge impact on bond prices going forward.


The right steps to take now

We cannot turn water into wine but we can help you avoid making mistakes that put your capital at risk. The summary today is that you cannot generate similar yields to 2000 with low risks. What you can do, however, is go back to basics:

  1. Adjust your financial plan. Reset your expectations, save more, spend less and work later. If your pension plan is underfunded, do not hope for financial markets to bail you out. We know this is not a pleasant truth but we prefer to tell an unpleasant truth than a comfortable lie.
  2. Review your asset allocation. The typical German investor has approximately 40% in bonds and 40% in cash & short-term deposits. With both categories yielding close to 0% percent (after fees, taxes and inflation even less), it is maybe time to adjust the asset mix. Large pension funds like the Norwegian Pension plan, which manages around $800bn, have a 60%-40% equity-fixed income split. Unless you have a specific reason, you shouldn’t deviate too much from that as a long-term investor.
  3. Reduce your costs. Balanced mutual funds are the most popular fund category in Germany. With annual fees of around 1.5% p.a. and often performance fees on top, you don’t have to be a financial genius to figure out that in a zero interest rate world, there will not be much left for you as an investor.