Summer is fully upon us. Every morning the rising sun wakes my children (yes you read that right, my kids are up at dawn every single day and no I don’t want to talk about it), and we see the temperature climb with the sun as it makes its way across the sky. Every now and then we’ll get a cooler day in the Midwest, as the temperatures will unexpectedly drop from the high they had experienced earlier in the week.
Why am I talking about the sun and the temperatures, you ask? Simply because they relate so well to the other topic we are hearing about so often – a topic that makes news with a rise and a fall and every movement in between – something referred to as yield.
Let’s start at the beginning and identify what yield is being discussed, how it changes, and what it means for investors.
What is a “yield”?
Generically put, “yield” is the income an investment generates over time.[1] Rental properties produce yield, stocks produce yield, bank accounts produce yield, and bonds produce yield. Yield is everywhere in the world of investments, yet the yield that is most commonly referenced on the media outlets is the yield on the 10-year Treasury. The 10-year Treasury is the benchmark for other important rates of interest, which is why it’s so heavily tracked, watched, and reported upon. As the 10-year Treasury fluctuates so do mortgage rates and other borrowing rates for individuals and businesses. Simply put, the 10-year is the designated benchmark for interest rates in the United States economy. When you hear the news noting “rates on the 10-year are rising” what they are referring to is the income the 10-year Treasury notes are paying their investors.
What does a change in yield mean?
To understand what a change in yield means, one must first understand how yields change in bonds. With bonds, yields and values are reversed. This means if the yield is rising, the price of the bond is falling.
Example – – > You bought a bond for $1,000 and it was yielding 2% at the time of purchase. If the demand for that bond grew and one month later the bond was worth $1,250, the yield would be less than 2% (I’m not going to do the exact math for this example, but you get the idea). Your bond is worth more, but it’s yielding less.
When you hear “the rates on the 10-year are falling” this also means that the price of the 10-year is rising. –More people are buying bonds and driving up the price. When you hear “the rates on the 10-year are rising” you can quickly supplant the opposite logic – demand for bonds is decreasing, driving the price down.
What does this mean for investors?
Let’s ask ourselves why the demand for bonds would rise and fall? Let’s also keep in mind the relationship between bonds and equities. Bonds, especially government bonds, are widely understood to be less volatile than equities. If investors are uncomfortable buying stocks for any number of reasons, they’ll often turn their attention to bonds. This means capital will flow into the bond market and away from the stock market, causing the bond market to rise in price. Using what we learned above, if the prices of bonds are rising, it means yields are falling, and if bonds are rising it seemingly signals investors are avoiding the purchase of equities, as they feel the investment into a bond is safer for their money. Thus, a rising yield signals bond prices are falling, signaling capital is flowing out of bonds and (assumingly) into equities.
So now we understand how a yield rises and falls – what does it mean? Within the last week, it’s meant that nerves around the Delta variant have caused yields to fall, indicating what is termed as a “flight to safety” in investing.
This is a great opportunity for me to get very dramatic, but candidly, it means what we’ve known all along about publicly traded markets. Different asset classes rise and fall all the time – sometimes daily – and there are different economic indicators to tell us where capital is flowing throughout the day. The reporting on the 10-year Treasury is one of those indicators. The movement of that specific rate tells us what the price of the Treasury is doing, and how mortgage rates are determined, among other things. If you’re allocated across different asset classes you will see your equities rise and your bonds fall, and vice versa. The yield on the 10-year treasury is merely a signal to tell us that is happening.
What should you as an investor do about it? Stay invested. Allocate your portfolio throughout different asset classes. Don’t fret when the media emphasizes the words “falling” or “plummeting” when it’s describing the yield. If that’s happening, you now know this means the fixed income asset you own is appreciating in value.
Most importantly – stick to your financial plan. You own bonds and equities for a reason and that reason was outlined by your advisor. Making changes to that plan based on daily movements of yield in your fixed-income portfolio doesn’t make any long-term sense. Going back to the sun and the temperatures, it’d be like me telling my kids we can’t go on vacation in 10-years because today’s temperature spiked to 105 degrees – we can all agree that would be nonsense.
If you need guidance creating a financial plan that fits your needs, we at BerganKDV can help. Contact your trusted financial advisor or start here.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.
[1] Retrieved on 11 July 2021 from: https://www.thebalance.com/what-is-yield-5093920
