You probably have financial goals—buying a house, paying off student loans, saving for a big vacation. But should you be saving or investing your money to achieve those goals? Are your investments or accounts earning sufficient yield?
While some people use the terms “saving” and “investing” interchangeably, they’re actually quite different. Saving generally means storing your money in a savings account. While investing means you’re taking a portion of your money and buying assets with the goal of growing your wealth. Those assets can produce income and gains on your investments.
Stock prices can go up or down. Some stocks also pay out dividends to shareholders, typically drawn from the company’s earnings. And that brings us to yield. What is yield? And why do you need to know the yield definition?
What Does Yield Mean?
In simple terms, yield is the income generated on a given investment over a set period of time. The yield definition is usually expressed as a percentage. Typically, yield is the interest earned or dividend paid out on a security over the course of one year.
Investments make money in a few ways:
• Appreciation: the value of property goes up over time or the stock price goes up
• Pass-through profits: private business or real estate can pass the profits through to investors
• Simple income: income in the form of cash paid to the investor (interest or dividends); simple income in the form of interest or dividends is known as yield
The meaning of yield is not the same as the meaning of return or rate of return. Return is a longer-term calculation of the total loss or gain on an investment, which takes into account all three ways investments make money. Yield only focuses on the cash flow and does not include capital gains.
While all investments have some kind of rate of return, not all investments have a yield, because not all investments produce interest or dividends.
How Do You Calculate Yield?
Yield is typically calculated annually, but it can be also be calculated quarterly or monthly. Also, yield is primarily focused on the realized cash return in that time. It does not, then, include changes in a stock’s market price.
Yield is calculated as the net realized income divided by the principal invested amount. Another way to think of the meaning of yield is as the investment’s annual payments to the investor divided by the cost of that investment.
For example, if a $100 stock pays out a $2 dividend for the year, then the yield for that year is 2 ÷ 100, so 0.02, or a 2% yield.
Return or rate of return, by comparison, is calculated differently. Yield is simply a portion of the total return. For example, if that same $100 stock has risen in market price to $120, then the return includes the change in stock price and the paid out dividend: [(120-100) + 2] ÷ 100, so 0.22, or a 22% total return.
The reason this matters is because the rate of return can change if the stock price changes, but often the yield on an investment is established in advance and generally doesn’t fluctuate too much.
Unless a dividend amount changes, investors know how much of a dividend they can expect from a stock. Bond interest payments are usually determined at the beginning of the bond’s life and remain constant until that bond matures.
One important thing to think about when doing yield calculations is whether you’re looking at the original price of the stock or the current market price. (That can also be referred to as the current market value or face value.)
For example, in the above example, you have a $100 stock that pays a $2 dividend. If you divide that by the original purchase price, then you have a 2% yield. This is also known as the cost yield, because it’s based on the cost of the original investment.
However, if that $100 stock has gone up in price to $120, but still pays a $2 dividend, then if someone bought the stock right now at $120, it would be a 1.67% yield, because it’s based on the current price of the stock. That’s also known as the current yield.
Frequently, if you’re looking at yields for various companies listed in an investment publication, you’ll see the current yields because they’re based on the current stock prices. But if you bought the stock at a different price, it’s important to remember that your yield may have not actually changed.
What Is the Yield Definition for Different Investments?
While the general yield meaning doesn’t change from one investment to another, the way it’s calculated can vary slightly. In fact, the SEC even has its own definition of yield .
Yield Meaning for Stocks
When you make money on stocks it often comes in two forms, as discussed above: as a dividend or as an increase in the stock price. If a stock pays out a dividend in cash to stockholders, the annual amount of those payments can be expressed as a percentage of the value of the security. This is the meaning of yield.
For stocks, yield is the dividend paid divided by the stock price, expressed as a percentage. For example, a stock with a $50 purchase price and a $1 annual dividend, has a 2% yield.
Many stocks actually pay out dividends quarterly. In order to calculate the annual yield, simply add up all the dividends paid out for the year and then do the calculation. If a stock doesn’t pay a dividend, then it doesn’t have a yield.
Note that real estate investment trusts (REITs) are required to pay out 90% of their taxable income to existing shareholders in order to maintain their status as a pass-through entity. That means the yield on REITs is typically higher than other stocks.
Yield Meaning for Bonds
When you buy a bond, the yield is the interest paid on that bond—which is typically stated on the bond itself. (However, if you buy a bond on the secondary market, then the yield might be different than the stated interest rate because the price you paid for the bond was different than the original price.)
For bonds, yield is calculated by dividing the yearly interest payments by the payment value of the bond.
For example, a $1,000 bond that pays $50 interest has a yield of 5%. This is the nominal yield. Yield to maturity calculates the average return for the bond if you hold it until it matures based on your purchase price.
Some bonds have variable interest rates, which means the yield might change over the bond’s life. Often variable interest rates are based off the set U.S. Treasury yield—more on that below.
Is There a Market Yield?
Treasury yields are the yields on U.S. Treasury bonds and notes . When there is a lot of demand for bonds, prices generally rise, which causes yields to go down.
The Department of the Treasury sets a fixed face value for the bond and determines the interest rate it will pay on that bond. The bonds are then sold at auction. If there’s a lot of demand, then the bonds will sell for above face value also known as a premium.
That lowers the yield on the bond, since the government only pays back the face value plus the stated interest. (If there’s lower demand, then the bonds may sell for below face value, which increases the yield.)
When Treasury yields rise, interest rates on business and personal loans generally rise too. That’s because investors know they can make a set yield on government securities, so other investment products have to offer a better return in order to be competitive. This affects the market in that it affects the rates on mortgages, loans, and in turn, market growth.
There isn’t a set market yield, since the yield on each stock and bond varies. But there is a yield curve that investors track which is a good reference. The yield curve plots Treasury yields across maturities—i.e., how long it takes for a bond to mature. Typically, the curve plots upward, since it takes more of a yield to convince an investor to hold a bond for a longer amount of time.
An inverted yield curve can be a sign of an oncoming recession and can cause concern among investors. While you don’t necessarily need to track 10-year Treasury yields or worry about the yield curve, it is good to know what the general yield meaning is for investors so you can stay informed about your investments.
Are You Getting a Good Yield on Your Investments?
Why does the definition of yield matter to you? Because you want to know if your investments are going to help you achieve your financial goals.
A high yield means more cash flow and a higher income. But a yield that is too high isn’t necessarily a good thing. It could mean the market value of the security is going down or that dividends being paid out are too high for the company’s earnings.
Of course, yield isn’t the only thing you’re probably looking for in your investments. Even when investing in the stock market, you may want to consider other aspects of the stocks you’re choosing: the history of the company’s growth and dividends paid out, potential for future growth or profit, the ratio of profit to dividend paid out. You may also want a diversified portfolio made up of different kinds of assets to balance return and risk.
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