I HAVE been getting a little bit irritated by the constant comparisons between the yield on equities and the yield on a bond or a term deposit.
The argument goes that equity yields are now higher than bond yields and higher than term deposits, so you should switch.
But the truth is that a comparison of the returns on term deposits or bonds with equity yields is lazy, and ridiculous and reckless, because it misses the point about why people are in term deposits in the first place.
Let me explain by taking a well-known income stock, National Australia Bank, one of the highest-yielding and safest blue-chip stocks in the market. The yield on NAB is 7.5 per cent, or 10.7 per cent, including franking. That, everyone will tell you, is cheap, and the argument is that all you mugs holding term deposits earning just 5.5 per cent are idiots because you get an extra 2.2 per cent in NAB, or 5.2 per cent, including franking.
Fair enough, until you consider this. Get a chart up of NAB over the past year. One year will do. Now mark off the peaks and troughs since January and calculate how many and how big the variations have been.
You will find that NAB has had 10 fluctuations. Five rallies and five falls. The size of the rallies has been 12.8 per cent, 17.8 per cent, 8.3 per cent, 23.2 per cent and 26.9 per cent. The falls have been 9.8 per cent, 15.3 per cent, 23.9 per cent, 13.5 per cent and 18.7 per cent. If we picked a smaller income stock, or took NAB out over a longer period, it would be even more dramatic.
Now tell me after 10 moves of more than 7.5 per cent in just a year that I should be worrying about the 7.5 per cent yield on NAB. Now tell me, amid that volatility and instability, that I should mention the yield on NAB and the yield on a risk-free term deposit or bond in the same breath. Now tell me the prudence behind selling my term deposit and buying NAB.
NAB, and almost all other income stocks in the market, are not stable, low-risk investments, they are volatile trading stocks, and the message is clear, and let's make it clearer, once and for all: you cannot compare the yield on an equity with the yield on a bond, because one includes no risk of a capital loss (no risk of a gain either) and the other contains a currently huge perceived risk of a capital loss (or gain).
Promoting income stocks because they yield more than a bond is ignoring that extra risk and misunderstanding why people are now in bonds and term deposits. They are there because they don't want to lose any more money. The only way to compare equities with bonds or equities with term deposits is if the equities came with a price guarantee, which they don't, or if you compared risk-free yields with the expected total return from equities, which includes the extra volatility and risk not just the dividends.
In the current market, equities are nothing like a bond or term deposit because share price risk is dominating the investment decision, not the yield. Do you really think people are in term deposits to make 5.5 per cent? No. They are in term deposits to avoid losing money.
But it's not all gloom. The good news is that this is not a normal state of affairs. The sharemarket is supposed to be about opportunity, not risk. Plus, risk can change quickly. Before the last European Union summit, the market jumped 11 per cent in four days on lower perceived equity risk. The banks jumped 19.2 per cent. If the global financial crisis does not happen, the focus is going rapidly to swing back to yields and price-earnings ratios.
If the GFC was behind us, how long do you think NAB is going to trade on a 10.7 per cent yield and the market on a P/E of 10.7 times against a long-term average of 14 times (25 per cent below average)?
Not long. In which case the game now is not debating the marginal merits of term deposits versus equities, but waiting for a chink of light in the outlook for risk. When it appears, the herd is going to smash down the door to get to those yields and P/Es. At the moment, understandably, they don't believe them. Your job is to be on the ball on the day that they do.
Frequently Asked Questions about this Article…
Why is comparing equity yields with bond or term deposit yields misleading for everyday investors?
Comparing equity yield vs bond yield or a term deposit rate is misleading because bonds and term deposits are effectively risk-free for capital (no price swings), while equities carry share price risk. An equity’s dividend yield doesn’t include the high volatility in its share price, so you should compare a risk-free yield with an expected total return from equities (dividends plus potential capital gains or losses), not just the dividend yield alone.
How volatile can a high-yielding blue-chip like National Australia Bank (NAB) be?
Even large, high-yielding banks can be very volatile. The article notes NAB had 10 significant moves in one year — five rallies (12.8%, 17.8%, 8.3%, 23.2%, 26.9%) and five falls (9.8%, 15.3%, 23.9%, 13.5%, 18.7%). That level of price movement shows dividend yield alone doesn’t capture the full risk.
If NAB yields 7.5% (10.7% including franking), why might someone still prefer a 5.5% term deposit?
People often choose term deposits not to chase a higher return but to avoid losing money. A term deposit’s return comes with virtually no capital-loss risk, whereas an equity yielding more (like NAB) still exposes you to significant share-price swings that can wipe out dividends in capital terms.
What does 'expected total return' mean and why is it important when comparing equities to bonds or term deposits?
Expected total return includes both dividend income and expected capital gains or losses from share-price movements. It’s important because comparing a risk-free yield (bonds/term deposits) with only an equity’s dividend yield ignores the capital-risk component of equities. A fair comparison needs the full expected total return of equities.
When should investors consider switching from term deposits to income equities?
According to the article, the sensible play is to wait for a clear improvement in the outlook for risk — a drop in perceived equity risk. Markets can shift quickly (for example, an 11% market jump in four days around an EU summit, with banks up 19.2%), so be ready to act when sentiment improves rather than switching just because equity yields look higher right now.
Are income stocks like NAB stable, low-risk investments?
No. The article emphasises that most income stocks, including NAB, behave as volatile trading stocks rather than stable, low-risk investments. Their dividend yield doesn’t remove the risk of capital loss or the potential for large price swings.
How do price-to-earnings (P/E) ratios factor into the decision between equities and bonds?
P/E ratios reflect how the market values earnings relative to price and can signal when yields and valuations might revert. The article points out a market P/E of about 10.7 versus a long-term average of 14; if risk perceptions normalise (for example, no repeat of a major crisis), P/Es and yields could move back toward long-term norms, changing how attractive equity yields look versus bond or term deposit rates.
What practical takeaway should everyday investors have about income investing and protecting capital?
The practical takeaway is to recognise the trade-off: term deposits and bonds protect capital but offer lower guaranteed yields, while income equities offer higher dividend yields but come with significant share-price risk. Don’t equate higher equity yield with lower risk — instead, consider your tolerance for volatility and wait for clearer improvements in market risk before switching from capital-protecting products to higher-yielding but volatile stocks.
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