When you invest money, you may want to invest in equity (stocks) or debt (bonds), to get an income return on your investment. Return on UK company stocks, or shares, is called "dividend yield," and return on bonds is "bond yield." Historically, in the long term, the real return, minus inflation, on UK equities is higher than the real return on bonds, according to Monevator.com. But over the short term, UK government bonds actually provide a more assured return. In order to examine why the yield differs, consider the risks associated with each form of investment.
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Risk And Return
A general rule in investing is, the higher the risk, the higher the return. Bonds are generally less risky than stocks, InvestinginBonds.com points out, because the issuer is obligated to return to the investor the face value of the bond at maturity. There is no such obligation to equity holders. Plus, if the bond carries a regular fixed rate of interest payment, the issuer is obligated to meet it. There is no obligation to pay dividends to shareholders. Individual stocks of a profitable company in good market conditions can be safer than risky bonds, however.
UK dividend yield and bond yield are calculated using the same financial ratio, according to Investopedia.com. Both are calculated as the annual amount of interest paid, divided by the market price. The UK dividend yield shows as a percentage how much a UK company pays out annually in dividends relative to the company's current share price. Bond yield is the effective rate of interest paid on the bond. It is the coupon amount--fixed interest rate on the bond at original par value--relative to the current bond price.
Yields Over Time
Barclays Capital Equity Gilt Study 2010, cited at Monevator.com, presents a comparison of UK real asset class returns (per cent per year) including UK stocks and bonds. In 2009, the real return on UK equities was 25.9 per cent, compared with UK government bonds at -3.3 per cent. Over 10 years, the real return on UK equities was -1.2 per cent, while government bonds brought 2.6 per cent. Over 20 years, the real return on UK equities was 4.6 per cent, and 5.4 per cent for government bonds. But over 50 years, the real return on UK equities was 5.2 per cent versus bonds' 2.3 per cent.
Analysing the Figures
Equity and debt provide different returns over time and are useful for different purposes, according to Monevator.com. Low-risk bonds such as government bonds are best for investing in the short to medium term, five to 10 years, because you know when you invest what return you will get--assuming you hold the bonds until they are redeemed. Stocks provide better returns in the long term (more than 20 years) because markets operate in periods of boom and bust, and over time, short term volatility is removed.
Financial advisers recommend investors have a portfolio of investments comprising different stocks and bonds, to effectively spread your investment risk. Given the volatility of stock markets and individual stocks, some financial advisers such as Mohamed El-Erian of Pacific Investment Management Co. recommend investors cut their stock exposure (including UK stocks) from around 60 per cent to between 30 and 54 per cent.
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