The simple number that makes an investment worthwhile

Questor: Never forget the bond market and the ‘risk-free rate’

Russ Mould

Published 30 March 2026

Questor, The Telegraph’s investing column, takes a weekly view of the markets – what is moving them, what lies ahead and how all of this could affect your portfolios and financial goals.

It has long since passed into lore that James Carville – once a senior adviser to Bill Clinton, the former US president – said that if there was such a thing as reincarnation, he would want to come back as the bond market so he could “intimidate everybody”.

At present, investors may be paying more immediate attention to the commodity markets – especially oil and gas – but they are doing so partly because of the possible knock-on effects that higher hydrocarbon prices could have upon inflation and, in turn, interest rates – all of which eventually hit the bond market.

From the end of the global financial crisis in 2009 to Covid-19 and Russia’s attack on Ukraine at the start of this decade, investors were able to take low inflation, low interest rates and low bond yields for granted.

The world is different now and, as a result, investors may need to think and approach markets in a different way if they are to protect and augment their wealth.

Gilt-edged option

The key benchmark to note is the 10-year gilt yield. This represents the “risk-free rate” for investors because, in principle, the British government will not default on its liabilities.

The last time the UK defaulted was the 1672 Stop of the Exchequer under King Charles II – although some financial market historians argue that 1932’s reduction of the 1917 War Loan coupon to 3.5pc from 5pc was tantamount to a default, even if the government portrayed the reduction as a voluntary one on behalf of patriotic investors.

In sum, the British Government will always make its interest payments (coupons) on time and return the initial investment (principal) once the bond matures, even if it must print money to do so. The investor will receive all the interest they are owed and their money back, assuming they buy the gilt upon issue and hold it until it matures.

At the time of writing, the 10-year gilt yield is 4.89pc. This is therefore the minimum, nominal, annual return on any investment that an investor should accept over their preferred investment time frame.

Risk measurement

The 10-year yield is approaching 5pc. That figure comfortably exceeds the 3.3pc forecast yield on the FTSE 100 for 2026.

The test now is whether investors settle for a higher risk-free rate and buy gilts, or stick with stocks, hoping for their near 7pc earnings yield, judging by the FTSE 100’s 14-times forward earnings multiple for this year.

At the same time, investors may also decide they want to pay lower valuations and prices for riskier assets such as equities because they do not need them quite so badly in their search for a return on their capital.

More things can go wrong with a shareholding than a bond, too – not least that the share price can go down, management can cut the dividend or the earnings forecasts can be wrong (or all three).

Ratings game

If gilt yields rise, investors are likely to demand higher returns from equities to compensate for the risk.

This can mean paying a lower valuation, or multiple of earnings and cashflow, but they can also demand a higher dividend yield. This can be achieved by increasing payouts or simply by buying at a lower share price.

Remember: the total return from a share is determined by capital return plus dividend yield. The capital return will be, in crude terms, a function of both earnings growth and the multiple or rating paid to access that earnings growth.

In its simplest form, the price-to-earnings (p/e) ratio is a helpful tool here.

Earnings will go up (or down) depending on the economic cycle and the fortunes of the company’s target industry, as well as the management’s strategy and business acumen.

Many factors can influence the price, or multiple, the investor wishes to pay – including the company’s finances, managerial competence and governance, as well as the predictability and reliability of its operations and financial performance.

Interest rates will have a big say in the multiple, too.

If gilt yields are rising, investors may feel less inclined to take risks and decide to pay lower prices and multiples, forcing a lower p/e in effect.

This maths helps to explain the FTSE 100’s pull-back from late February’s record high. Equally, the opposite can hold true, as evidenced between 2009 and 2021 when share indices rose as interest rates hit – and stayed at – rock bottom.

However you invest, never forget the bond market.