For most of the decade to 2021, government bonds paid so little that many retirees stopped thinking about them altogether. The Australian 10-year government bond yield fell below 1% during 2020, which meant lending money to the government for a decade earned less than inflation. That has changed. In September this year the 10-year yield reached around 5.4%, its highest level since 2011, and it remains a little above 5%. For anyone relying on their investments for income, bonds deserve a fresh look.
What a bond is, and why its price moves
A bond is a loan. When you buy one, you lend money to a government or a company, which pays you interest at regular intervals and repays the original amount on a set date. Held to maturity, a high-quality bond returns exactly what it promised.
Bonds can also be bought and sold before they mature, and that's where prices move. If interest rates rise after a bond is issued, new bonds pay more, so the older bond becomes less valuable and its price falls. If rates fall, the older bond's higher interest becomes more attractive and its price rises. This inverse relationship between rates and bond prices is the one idea that explains most of what bonds do.
Why bonds fell out of favour
Two things pushed investors away. The first was years of very low income, when term deposits and bonds alike paid next to nothing. The second was 2022, when central banks lifted interest rates quickly and bond prices fell sharply. Measured by the main Australian bond index, it was the worst year on record for fixed-rate bonds, and the memory of an investment marketed as defensive losing money has kept many people away since.
The irony is that the losses of 2022 are what created today's opportunity. Higher rates hurt bond prices on the way up, but they also mean bonds bought now pay meaningfully more income. The yield at the time of purchase is the best single guide to the return a bond will deliver over its life.
How bonds compare with cash and shares
The comparison below is general, and the right mix depends on each person's circumstances, but it shows where bonds sit between the two assets most retirees know best.
| Term deposit | Government bonds (through a fund) | Australian shares | |
|---|---|---|---|
| Income | Fixed rate for the term | Regular interest, around 5% on 10-year bonds at present | Dividends, which can vary |
| Capital value | Stable | Rises when rates fall, falls when rates rise | Can rise or fall sharply |
| If the economy slows | Lower rate at the next rollover | Often holds or gains value | Often falls |
| Access to money | Locked for the term | Usually within a few days | Usually within a few days |
| Main risk | Inflation eroding real value | Further rate rises and inflation | Market falls |
Index funds versus active management
Bond markets work differently from share markets, and that shapes how bonds are best held. Most bonds don't trade on an exchange like the ASX. They're bought and sold privately between banks and investors, many issues trade only occasionally, and prices are often quoted rather than set by a visible market. The payoff is different too. A share has no ceiling, so one outstanding company can make up for several poor ones, while a bond's best outcome is fixed in advance and its worst is a default. In bonds, avoiding the problems tends to matter more than finding the winners.
The way bond indices are built adds to this. A share index weights companies by their market value, but most bond indices weight issuers by how much debt they have outstanding, so the heaviest borrowers carry the most weight. Issuers effectively set their own weights, and the main Australian bond index is now around four-fifths government debt and only around an eighth corporate bonds. Its sensitivity to interest rates has also crept up, rising by more than half in the decade to 2018 as governments issued longer-dated bonds, so index investors took on more interest rate risk without choosing to. An index fund must accept all of this, and it generally can't sell a weakening issuer until the index itself changes.
Index funds still have strengths. Fees are low, holdings are transparent and diversification is broad. An active manager, however, can favour stronger borrowers, sell an issuer before a downgrade forces the index to act, adjust interest rate sensitivity as conditions change, and take advantage of mispricing in a market that is less efficient than the share market.
The evidence offers some support. S&P Dow Jones Indices' research to June 2026 found roughly a third of active Australian bond funds trailed their index over three years, compared with more than four in five active Australian share funds. Over ten years, around three in five active bond funds fell behind. Fees and inconsistency play a part, but so does the index's own structure. Through the decades of falling interest rates that led to the post-COVID lows, the index's growing tilt towards longer-dated government bonds worked strongly in its favour, a tailwind that reversed sharply in 2022. The case for active management is stronger in bonds than in shares, but the choice of manager matters, and many portfolios combine the two by using an index fund as a low-cost core alongside an active manager.
Where bonds fit in a retirement plan
In retirement, bonds sit in the defensive part of a portfolio alongside cash, but the two do different jobs. Cash covers spending over the next year or two, while bonds suit money that won't be needed for a few years, in return for locking in today's higher income for longer. A term deposit rolled over each year will follow rates down when they fall, while a bond fund keeps earning the yields it bought and its value tends to rise.
The mix of bonds matters too. Shorter-dated bonds move less when rates change, while longer-dated bonds offer more protection if a recession prompts rate cuts, at the cost of larger swings. Government bonds carry the least risk of default, high-quality corporate bonds pay a little more, and inflation-linked government bonds adjust their value in line with the Consumer Price Index.
Bonds can also help manage sequencing risk, the danger of a sharp share market fall just as withdrawals begin. When shares fall because the economy is weakening, high-quality bonds have tended to hold or gain value, giving retirees something else to draw on while markets recover. That protection isn't guaranteed, and when inflation is the problem, shares and bonds can fall together.
Most people hold bonds through a managed fund or exchange-traded fund. After years in which the defensive part of a portfolio earned very little, bonds can once again provide meaningful income while still doing their traditional job of steadying a portfolio when shares fall.
References
Trading Economics, Australia 10Y bond yield hits 15-year high, 15 September 2026.
Trading Economics, Australia 10Y yield rises as RBA rate hike looms, 2 November 2026.
FIIG Securities, 2020, a year no one will forget, 1 December 2020.
Betashares, Bonds are back, 5 July 2023.
Investor Daily, Aussie bonds shake off boring cousin reputation, 22 May 2026.
W1M (Waverton Investment Management), The perils of passive bond investing, 21 July 2022.
Money Management (Chamath de Silva, Betashares), Bond composites and duration: an inconvenient truth, 27 July 2018.
Betashares, Enhancing Australian fixed income indexing, data as at 31 December 2024.
S&P Dow Jones Indices, SPIVA Australia Mid-Year 2026, period to 30 June 2026.
Australian Government Bonds (AOFM), Exchange-traded Treasury Indexed Bonds (eTIBs) explained, accessed 3 November 2026.