What is the yield gap?
The yield gap is the difference in return between government bonds and common stock. It’s essentially a measure of how much risk investors are willing to take in certain economic climates.
Where have you heard about the yield gap?
Before 1959, shares returned more than government bonds, as you might expect, but after that there was a reverse position as inflation eroded the value of capital until the financial crisis. Since 2008, a positive yield gap has begun to re-establish itself as investors stick to low-risk bonds ahead of stocks, which potentially give better returns, but are riskier.
What you need to know about the yield gap.
The yield gap is calculated as the dividend yield of equities minus the yield on long-term government bonds. It’s a useful measure of whether shares are overpriced in relation to bonds. An abnormal yield gap can be rationalised by higher or lower growth expectations.
The yield gap also highlights changes over time. For example, if companies increasingly turn to share buybacks rather than issuing dividends, the yield on shares will fall.
Find out more about the yield gap.
Read our definition of government bond to learn more about this type of low-risk investment.