Reality #4 The 2018 Russell Investments/ ASX Long Term Investing Report shows that over the last decade, there have been periods where bonds have outperformed shares. However over the longer term, investors should expect shares to show higher returns given they are higher risk
Bonds range from being very low risk government bonds returning 2%pa to high risk corporate bonds earning 10%pa or more. There are other fixed income options such as deposits and structured investments like Residential Mortgage Backed Securities (RMBS) to provide a very wide range of risk/ return options, which would suit all investors.
Bonds will always be lower risk than shares in the same company as they sit higher in the capital structure. So, in the event of default they are repaid before shares and other lower ranking creditors. The exceptions being subordinated financial institution bonds and hybrids which convert to shares or are written off under certain conditions.
Typically investors would expect returns on shares to outperform bonds, but that is not necessarily the case.
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The Russell Investments/ ASX Long Term Investing Report shows gross returns by asset class, as shown in Figure 1 below. They indicate global fixed income (hedged) was the second highest returning asset class in the ten years to December 2016 (grey bars on chart) returning 7.4%, after residential property which returned 8.8%. In the same year, Australian fixed income ranked third, with a 6.2% return. Australian shares ranked 5th behind Global shares (unhedged).
For the ten years to December 2017 (blue bars on chart), Australian fixed income still returned 6.2% compared to Australian shares which had declined from the previous year to 4%. Global shares (hedged) improved to 7.2%, taking second place from Global fixed income (hedged) at 7.1%.
Gross return comparison – 10 years to December 2017 versus December 2016
Source: Russell Investments / ASX Long Term Investing Report
While you would expect lower returns for lower risk, investing in fixed income doesn’t mean it will be a drag on your portfolio’s performance.