By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Overview
Real yields, otherwise referred to as real interest rates, are a term used to describe an asset’s yields once adjusted against inflation. This term is commonly associated with bonds but can refer to many other assets such as loans. In this article, we go over common applications of the yield and how you can use it to make good financial and investment decisions.
How to Calculate Real Yield
The real yield is the interest rate from an asset such as a bond, subtracted by the rate of inflation:
Real Yield = Nominal Interest Rate – Inflation (Expected or Actual)
For example, if I were to buy a 10 year US Treasury Bond at a price where I could get a yield of 5%, and inflation is at 3%, then my real yield would be 2% since subtracting 3 from 5 equals 2.
Negative Real Yields In The Current Bond Market
In the present day, with high inflation (6.8% last year) and low Treasury yields (around 1.7%), the US bond market is actually producing negative real yields. Referring to the chart below, you can see that in recent years, real yield dips below the benchmark of 0, heading into the negative:
Source: Yardeni Research
What this means, is that putting your money into bonds will actually net you a negative yield when adjusted for inflation.
What This Means For You
While bonds are certainly not obsolete (buying bonds is still better than stashing cash under your bed), and inflation is expected to drop to around 2-3% in 2022, real yields will still be negative, and having your wealth be slowly eaten up by inflation is not ideal.
In our current economic environment, even for the most conservative of investors, it is absolutely necessary to look for alternative investments in places such as the stock market and real estate. This advice has been repeated for years by great investors such as Warren Buffet, who has repeatedly said fixed-income investors face bleak futures. After all, one of the biggest risks is taking no risk at all, and letting inflation shrink your hard-earned wealth is far worse than taking a little more risk, with the upside of real positive returns!
