5.5% yields and a 200bp gap: Why bonds may beat equities for income in 2026

The same companies paying you dividends may be offering even more income through their bonds. And unlike dividends, those payments are legally required.

Kellie Wood, Fixed Income Portfolio Manager at Schroders Australia, believes bonds should be front of mind for investors searching for income in today’s market.

“Corporate bonds are offering higher yields than the equity dividend yield in a lot of cases.”

It is a striking shift for investors who built their portfolios during the post-GFC decade, when near-zero interest rates made equities the obvious place to hunt for yield.

Today’s environment looks very different. Inflation has returned, interest rates are structurally higher, and central banks around the world are moving in different directions. That shift is opening up opportunities in fixed income that have not been available for years.

In fact, Wood believes 2026 may offer one of the most attractive environments for income investors in recent memory.

Same company, very different yield

Let’s start with the numbers.

Woolworths (ASX: WOW), a staple of Australian income portfolios and a reliable blue-chip name, currently yields around 3.4% in dividends.

A Woolworths corporate bond, rated BBB, is paying about 5.5%.

That is a 210 basis point (bps) gap in favour of the bond from the same underlying company.

Wesfarmers (ASX: WES) – the parent behind Kmart, Bunnings and Target – tells a similar story. The equity dividend yield sits at 3.7%. The bond? 5.4%. Another 170 bps sitting on the table.

“With equity valuations being expensive and equity not delivering on the income component, you can now get better yields in high-quality fixed income corporate bonds.”

This is not to say equities do not deserve a place in income portfolios. But in the current environment, income hunters may need to look beyond traditional dividend stocks.

Another key difference between equities and bonds that rarely gets discussed is the legal obligation behind the income.

Dividends are optional. Companies can cut, suspend or eliminate them at any time. During COVID, during the GFC, and during any stretch of earnings pressure, dividends were among the first casualties. 

However, bond coupons are different. They are a legal obligation.

“The coupon payment, the income payment on bonds, is a legal obligation. Dividends are not.”

For income-focused investors, particularly retirees relying on regular cash flows, that distinction is critical. Bond income isn’t conditional on a good quarter or a board decision. It’s contractual.

Higher yields? Check.

Legally obligated to pay income? Check.

In an environment where equity valuations remain elevated, Wood believes investors should be asking whether they are being adequately compensated for the risk they are taking in equities relative to fixed income.

For multi-asset portfolios, that shift is already changing asset allocation decisions. Wood says her team now holds more high-yielding credit than equities across some portfolios.

Valuations: equities are expensive, credit is not

The income gap is not happening in isolation. It is also sitting alongside a valuation environment that is becoming increasingly stretched in parts of the equity market, particularly in US tech stocks.

Meanwhile, Wood believes the fixed income opportunity set looks comparatively attractive and her multi-asset portfolios have already shifted in response.

“We’re now owning more high quality credit or high yielding credit than what we are equities.”

Most retail investors access high-quality corporate credit issued by companies such as Woolworths and Wesfarmers through managed funds, ETFs and specialist bond platforms.

Australian investment-grade credit spreads also remain attractive relative to global peers. An asset class once viewed as the quieter cousin of equities is now providing meaningful income.

“It’s a valuation argument, but also an income argument. Where should we be going for income in this environment? That’s in the high-yielding credit space,” Wood says.

Why 2026 may be particularly well timed

The conditions creating such a stark income gap between equities and bonds may not last forever. That is why Wood believes today’s market offers one of the strongest opportunities fixed income investors have seen in years.

“We’re in a higher for longer rate environment,” she says. Inflation remains sticky, growth has held up better than many expected and central banks in markets such as Australia and the US are not rushing to aggressively cut rates.

That combination keeps bond yields elevated. While higher yields can weigh on bond prices, they are extremely supportive for investors seeking income.

At the same time, traditional government bonds have not been behaving like the portfolio diversifiers many investors expected. In a higher inflation world, their correlation with equities has been far less reliable.

Wood’s approach is to look beyond sovereign debt and focus on parts of the fixed income market better suited to this environment, including corporate credit, emerging market debt and other high-yielding assets.

A very different investment regime

Part of the reason bonds are becoming more attractive today lies in the broader macro environment.

Wood argues the decade following the GFC was highly unusual.

“The GFC decade was unusual because we had low growth, low inflation and structurally low interest rates. Everything moved together.”

Today’s environment looks very different. Inflation has returned, fiscal policy is expansionary and economies are moving through the cycle at different speeds.

That dispersion across markets creates opportunities for active fixed income managers to allocate capital dynamically between countries and asset classes.

It also raises questions about how investors access fixed income. Many investors use passive bond indices, assuming they provide simple, diversified exposure. But Wood says investors should look closely at what those indices actually hold.

“When you buy a passive bond index, you’re largely lending money to governments.”

Most major bond indices are dominated by sovereign debt because of how they are constructed. Unlike equity indices, which weight companies by market capitalisation, bond indices are weighted by the amount of debt issued.

As Wood explains in The case for active fixed income: Navigating the new regime: “Unlike equity indices, where weight is determined by market capitalisation, bond indices are market-value weighted based on total outstanding debt. In this framework, the largest borrowers, typically sovereign governments, command the highest weights.”

In practice, this means the more a government borrows, the larger its representation becomes in passive portfolios.

In an environment where government debt levels are rising globally, Wood believes investors should question whether those yields adequately compensate them for the risk. Her preference is to focus on corporate credit, where leverage levels can be lower and yields more attractive.

What this means for your portfolio

None of this is to say investors should sell their shares and pile into bonds. Equities still offer capital growth and diversification. But Wood’s framework challenges a common assumption among Australian investors: that dividend stocks are the natural home for income.

Right now, the same companies whose shares you hold for yield are paying more income through their bonds; income that is legally protected rather than discretionary. It's a shift that doesn’t require taking on additional risk to access. Woolworths BBB credit, for example, is not a speculative punt. It’s a high-quality debt obligation from a business you already trust enough to own equity in.

For investors who built their income strategy in a world of near-zero interest rates and low bond yields, it may be time to revisit those assumptions. The math has changed. The income is still there; it’s just sitting in a different place. 

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