Question
I notice that virtually all ITs and OEICs pay a yield of between 0 to 5%, which is better than most savings accounts at the moment.
What happened back in the days when savings accounts paid 10 to 15% interest - did the ITs and OEICs still pay up to 5% more than savings accounts?
So what do you expect to happen this time around, to the average Income producing OEIC or IT, when the bank rate goes up from it's current low?Answer
Yield refers to the income paid by an investment divided by its price. To answer your question, it really depends on the type of investments held in the fund. As most funds invest in either stock market shares or corporate bonds, let's look at both of these.
Share income comes from the dividends that companies pay and is always quoted net of basic rate tax (for UK companies/funds). These tend to rise over time (unless the company has financial problems), but the yield will also depend on the share price. For example, suppose a company pays a 3p annual dividend and its share price is 100p, the yield is 3%. Let's assume it raises the dividend to 4p the following year - if the share price is still 100p the yield will be 4%, a share price of £133 would keep the yield at 3% while a share price of 150p would see the yield fall to 2.67%.
Yields of around 3% have generally been the norm for UK shares over the years, with dividends tending to keep pace with share price rises. When markets crash yields might rise above this, as dividends tend not to fall as much as share prices, while yields might fall a little during periods of soaring share prices.
Of course, some companies pay no dividends at all (i.e. zero yield) while others pay higher than average, but the above generally holds true. So, when interest rates were above 10% back in the mid to late eighties dividend yields would have looked low by comparison.
However, the bigger slice of long term stock market investment returns normally comes from rising share prices, so yield is only one part of the equation. For example, a stock market fund might yield 5%, but you'll still lose money if its price falls by more than 5% over the year.
Also, just because stock market yields tend to stay fairly level it doesn't mean you won't benefit from holding dividend shares long term. For example, suppose you buy a share at 100p with a dividend of 3p. 10 years later the dividend has risen to 6p and the share price is 200p. The yield is still 3% (6p/200p), but your original 100p investment is producing 6p annual income, an equivalent yield of 6%.
Corporate bond yields are more influenced by interest rate movements.
A corporate bond is an IOU issued by companies on which they promise to pay a fixed rate of interest before repaying the loan on a fixed date in future. For example, a company might issue a bond promising to pay 5p annual interest for 20 years per 100p borrowed - a yield of 5%. If savings account interest is less than 5% and you think the company is safe (i.e. they'll repay your interest and loan) then you might buy it. But suppose you can earn 10% in a savings account, no-one would bother buying the bond. So the bond's price would fall to make the yield competitive - in this example probably to 50p or less to give a yield of at least 10% (5p/50p).
So corporate bond yields will tend to mirror interest rates, but if you already own the bond then a rising yield means the bond's price is falling - potentially losing you money if you decide to sell.
In summary, I wouldn't expect higher interest rates to make much difference to stock market dividend yields but they would probably push up corporate bond yields.
I notice that virtually all ITs and OEICs pay a yield of between 0 to 5%, which is better than most savings accounts at the moment.
What happened back in the days when savings accounts paid 10 to 15% interest - did the ITs and OEICs still pay up to 5% more than savings accounts?
So what do you expect to happen this time around, to the average Income producing OEIC or IT, when the bank rate goes up from it's current low?Answer
Yield refers to the income paid by an investment divided by its price. To answer your question, it really depends on the type of investments held in the fund. As most funds invest in either stock market shares or corporate bonds, let's look at both of these.
Share income comes from the dividends that companies pay and is always quoted net of basic rate tax (for UK companies/funds). These tend to rise over time (unless the company has financial problems), but the yield will also depend on the share price. For example, suppose a company pays a 3p annual dividend and its share price is 100p, the yield is 3%. Let's assume it raises the dividend to 4p the following year - if the share price is still 100p the yield will be 4%, a share price of £133 would keep the yield at 3% while a share price of 150p would see the yield fall to 2.67%.
Yields of around 3% have generally been the norm for UK shares over the years, with dividends tending to keep pace with share price rises. When markets crash yields might rise above this, as dividends tend not to fall as much as share prices, while yields might fall a little during periods of soaring share prices.
Of course, some companies pay no dividends at all (i.e. zero yield) while others pay higher than average, but the above generally holds true. So, when interest rates were above 10% back in the mid to late eighties dividend yields would have looked low by comparison.
However, the bigger slice of long term stock market investment returns normally comes from rising share prices, so yield is only one part of the equation. For example, a stock market fund might yield 5%, but you'll still lose money if its price falls by more than 5% over the year.
Also, just because stock market yields tend to stay fairly level it doesn't mean you won't benefit from holding dividend shares long term. For example, suppose you buy a share at 100p with a dividend of 3p. 10 years later the dividend has risen to 6p and the share price is 200p. The yield is still 3% (6p/200p), but your original 100p investment is producing 6p annual income, an equivalent yield of 6%.
Corporate bond yields are more influenced by interest rate movements.
A corporate bond is an IOU issued by companies on which they promise to pay a fixed rate of interest before repaying the loan on a fixed date in future. For example, a company might issue a bond promising to pay 5p annual interest for 20 years per 100p borrowed - a yield of 5%. If savings account interest is less than 5% and you think the company is safe (i.e. they'll repay your interest and loan) then you might buy it. But suppose you can earn 10% in a savings account, no-one would bother buying the bond. So the bond's price would fall to make the yield competitive - in this example probably to 50p or less to give a yield of at least 10% (5p/50p).
So corporate bond yields will tend to mirror interest rates, but if you already own the bond then a rising yield means the bond's price is falling - potentially losing you money if you decide to sell.
In summary, I wouldn't expect higher interest rates to make much difference to stock market dividend yields but they would probably push up corporate bond yields.
Read this Q and A at http://www.candidmoney.com/questions/question479.aspx
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