Mainstream assessments of the state of investment markets tend to focus on the equity market. The level of the FTSE 100, S&P 500, Dow and/or Nikkei is deemed to be an indicator of the health of savers’ investment portfolios and/or savings’ programmes. These metrics are indeed likely to be relevant, to the extent savers’ portfolios are exposed to these markets, but are generally less important than the level of bond yields. The level of what??? Bond yields matter to most savers who have defined savings goals. The reason yields matter is that they allow savers to work out how much they need to set aside today in order to meet their goals. Government bonds, particularly those issued by governments that control their own currency, are widely considered to be ‘risk free’ for savers in the country in question (a detailed discussion of this point is beyond the scope of this brief blog). If the saver determines the quantum of government bonds necessary to meet their goals, buying and holding the bonds will deliver the cash flows specified by those bonds and will result in the goals being met. If the government in question defaults on the bonds, the saver is likely to be facing bigger economic issues than those relating to his/her savings goals. The saver might choose to take on investment risk in a number of ways. Instead of holding government bonds, the saver might prefer to hold corporate bonds. These corporate bonds usually offer a higher rate of return than the corresponding government issues due to the extra credit risk. The higher risk taken on and associated increased return allow the saver to set aside less capital in trying to reach the savings goals. Investment risk might also be taken by investing in non-bond assets – enough of this digression for this blog. Sterling bond yields have been in a secular decline since the 1970s, save for a few bumps along the way, with particular downward momentum for most of the past 25 years. These falling yields have driven up the amount of capital savers need to hold in order to meet a specified goal. For example, a saver looking to make a payment of £100 at the end of 10 years needed to put the following amounts aside in a UK Government Bond (using the yield on the first day of January available on the Bank of England’s website, where the data set starts in 1982):
- 4 January 1982 (yield of 15.1% p.a.) – £24.58
- 2 January 1992 (9.3%) – £41.28
- 2 January 2002 (5.0%) – £61.57
- 3 January 2012 (2.2%) – £80.80
- 16 January 2015 [most recent available] (1.6%) – £85.36
How many savers have increased their savings rates by 6% over the last three years, let alone 350% over the last three decades, merely to try target the same outcome? The impact of falling yields is even more significant for longer-term savers, such as those saving for retirement, as those savers are invested (and exposed to yields) for longer. What proportion of saving strategies has been crushed by falling yields? Ideally, more attention will be paid to bond yields than equity markets by savers who have clear goals and their advisers. I am conscious that focusing on bond yields might paint a very gloomy picture for many savers. However, the sooner a problem is recognised, the sooner it can be addressed. Ignoring the impact of bond yields is not going to make the problem go away. The only thing that is going to go away quicker in these circumstances is the saver’s accumulated capital once this capital begins to be drawn down. The challenge is how to communicate bond yields in a way that is relevant to savers. All suggestions are welcome – please set them out in the comment section below.