Yield is the income earned from an investment, most often in the form of interest or dividend payments. Yield is one of how investments can earn money, with the other being the eventual closing of a position for profit.
Yield refers to the interest earned or dividends received from holding a specific security. Depending on whether the security’s valuation is fixed or fluctuating, yields can be categorized as known or anticipated.
Formula for Yield
Yield is a way to measure the cash flow that an investor receives from their investment in a security. It’s often calculated annually, but can also be computed quarterly or monthly. Gross yield is the return on investment before taxes or other expenses are deducted. However, it’s important not to confuse yield with total return, which is a broader measure of investment performance.
Net yield, or net realized return, is calculated by dividing the net realized return by the principal amount invested.
Yield = Net Realized Return / Principal Amount
For example, gains from stock investments can come from price appreciation or dividends. If an investor buys a stock at $100 per share and sells it for $120 after a year, while also receiving a $2 dividend per share, the yield is calculated by adding the appreciation and dividends, and then dividing by the original price:
($20 + $2) / $100 = 0.22, or 22%
What Yield Can Tell You
When investors talk about yield, they mean the amount of money they get from their investments. If the yield is high, it suggests the investor is getting more money back. People often think a high yield means less risk and more income. But it’s important to understand how the numbers are calculated. Sometimes a high yield happens because the value of the investment is going down. This makes the yield look better even if the investment isn’t doing well.
People usually like getting dividends from stocks. But they also need to watch the yields. If the yield gets too high, it might mean the stock price is dropping or the company is paying out a lot in dividends.
Dividends come from a company’s profits. So, higher dividends could mean the company is making more money, which might raise the stock price. If the dividends go up and the stock price goes up too, the yield should stay about the same or go up a bit. But if the yield jumps a lot without the stock price going up, it could mean the company is paying out dividends without making more money. This could signal problems with their finances in the short term.
Types of Yields
Yields can change depending on what you invest in, how long you invest for, and how much you get back.
Yield on Stocks
For investments in stocks, people often use two types of yields. One is called the yield on cost (YOC) or cost yield. It’s figured out by looking at the price you bought the stock for.
Cost Yield = (Price Increase + Dividends Paid) / Purchase Price
For example, if you bought a stock for $100 and later sold it for $120, making a $20 profit, and you got $2 in dividends, your cost yield would be ($20 + $2) / $100 = 0.22, or 22%.
However, some investors prefer to calculate the yield based on the current market price instead of the purchase price. This is called the current yield.
Current Yield = (Price Increase + Dividend Paid) / Current Price
For instance, if the current price of the stock is $120, then the current yield would be ($20 + $2) / $120 = 0.1833, or 18.33%.
When a company’s stock price goes up, the current yield usually goes down because of how yield and stock price relate to each other.
Yield on Bonds
Calculating the yield on bonds that pay interest annually is pretty simple. It’s called the nominal yield. You just divide the annual interest earned by the face value of the bond.
For example, if you have a Treasury bond with a face value of $1,000 that pays 5% interest annually, the yield is $50 divided by $1,000, which equals 0.05 or 5%.
But for bonds with floating interest rates, where the interest changes during the bond’s life, the yield changes too.
For instance, if a bond’s interest rate is based on the 10-year Treasury yield plus 2%, and the 10-year Treasury yield is 1%, then the bond’s interest rate would be 3%. If the 10-year Treasury yield rises to 2%, the bond’s interest rate would become 4%.
Likewise, for index-linked bonds, where the interest payments depend on an index like the Consumer Price Index (CPI), the interest earned changes based on how the index value changes.