What has actually happened?
Over the past week, government bond yields here and around the world have risen to their highest levels in about 15 years. Australia's 10-year government bond yield has climbed above 5%, and similar moves have played out in the United States, the United Kingdom and Japan. One commentator described it as a "once-in-a-generation" sell-off. On the surface, that sounds alarming, so it is worth explaining what it actually means.
What is a bond sell-off, and why does it matter?
A government bond is essentially a loan an investor makes to the government. In return, the investor receives interest (the "yield") and has their capital repaid at the end of the term. When commentators talk about bonds being "sold off," they mean investors are demanding a higher yield to hold them, largely because of ongoing concern about inflation and government debt levels.
The part that unsettles people is this: when yields rise, the market price of bonds already on issue falls. So a diversified portfolio may show a short-term dip in the value of its bond holdings. That is the "negative" behind the headlines. But it is only half the story.
So why might this be good news?
Because higher yields mean the income being generated on newly invested money is the strongest it has been in well over a decade. For a retiree drawing an income, that is a more important consideration than a short-term movement in valuations.
For clients who hold a meaningful allocation to bonds, term deposits and cash, as most retirees sensibly do, those assets are now being paid considerably more than they were during the near-zero interest rate years. The defensive part of a portfolio is doing more of the heavy lifting, which strengthens the reliability of retirement income. In other words, the very shift making headlines can work in a retiree's favour.
Who is most affected?
The impact differs depending on where a client sits.
Those on a balanced or moderate risk profile will notice it most, simply because bonds, term deposits and cash make up a larger share of their portfolio. The trade-off, however, is a favourable one over time: some short-term movement in valuations in exchange for stronger and more dependable income.
For younger clients on a growth or high-growth profile, this has very little bearing on the long-term plan. Their capital is invested predominantly in shares and other growth assets rather than bonds. There may be short-term volatility along the way, but over a multi-decade horizon this is noise rather than signal and reacting to it is usually the most costly response of all.
How are we thinking about it?
Our approach here is consistent with the way we approach most market events. A few lessons are worth keeping in mind:
- Markets are unpredictable in the short run and market timing is difficult.
- The income now available on defensive assets is materially better than it has been for many years.
- The temptation in noisy markets is to "do something", move into cash, chase the highest term deposit rate, or abandon a defensive allocation. More often than not, that locks in the downside and forgoes the improved income.
- Term deposits are offering attractive yield and can be recommended were appropriate with deployable cash.
The Key Questions We Are Asking Ourselves
- Is this a sign of an impending market failure? No. Rising yields reflect concern about inflation and government debt, not a systemic breakdown of the kind we saw during the GFC or the onset of COVID.
- Does it change the job of a retirement portfolio? Not fundamentally. If anything, higher yields improve the income the defensive portion can generate.
- Should clients be reacting to it? No. The more useful exercise is to check that an income strategy and defensive allocation still match a client's stage of life and drawdown needs, not to predict the Reserve Bank's next move, which even the major banks currently disagree on.
Conclusion
Rising bond yields make for unsettling headlines, but for retirees drawing an income they can quietly work in your favour. Yes, valuations may move in the short term, and that is felt most by balanced and moderate profiles. But higher yields mean higher income, and for clients whose plans are built to capture that, this is a moment to stay the course rather than react to the noise. As always, we continue to monitor conditions closely and will revisit our assessment should circumstances change materially.
If you would like to review how your income strategy is positioned for this environment, we are always happy to talk it through.
General advice warning: This article contains general information only and does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider its appropriateness having regard to your own circumstances, and seek personal financial advice.
Malhi Wealth Management Pty Ltd ABN 633 146 433 ATF MJMalhi Family Trust ABN 56 973 759 569 t/a Malhi Private Wealth is a Corporate Authorised Representative (No. 001283127) of Provident Advisory Pty Ltd ABN 97 633 777 492 AFSL 549697 trading as Provident Advisory.