Yield is the income generated by an investment over a period of time. Yield is typically calculated by taking the dividend, coupon or net income earned, dividing the figures by the value of the investment, then calculating the result as a percentage.
Yield is not the same as return or the rate of return. Yield is a way to track how much income was earned over a set period, relative to the initial cost of the investment or the market value of the asset.
Meanwhile, return is the total loss or gain on an investment. Returns often include money made from dividends and interest. While all investments have some kind of rate of return, not all investments have a yield, because not all investments produce interest or dividends.
Here’s a closer look at the concept of yield and how to calculate it.
How Do You Calculate Yield?
Yield is typically calculated annually, but it can also be calculated quarterly or monthly.
Yield is calculated as the net realized income divided by the principal invested amount. Another way to think about yield is as the investment’s annual payments divided by the cost of that investment.
Here are formulas depending on the asset:
= Dividends Per Share/Share Price X 100%
= Coupon/Bond Price X 100%
= Net Income From Rent/Real Estate Value X 100%
For example, if a $100 stock pays out a $2 dividend for the year, then the yield for that year is 2 ÷ 100 X 100%, or a 2% yield.
Cost Yield vs. Current Yield
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.
Rate of Return vs. Yield
Calculating rate of return, by comparison, is done 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.
Definition of Yield for Different Investments
Yield in Stock Investing
When you make money on stocks it often comes in two forms: 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 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 dividend 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 for other stocks, which is one of the pros for REIT investing.
Sometimes investors also calculate a stock’s earnings yield, which is the earnings over a year, dividend by the share price. It’s one method an investor may use to try to value a stock.
Yield in Bond Investing
When it comes to bonds vs. stocks, the yield on a bond is the interest paid—which is typically stated on the bond itself. Bond interest payments are usually determined at the beginning of the bond’s life and remain constant until that bond matures.
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 from 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.
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 issued products, 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.
Crypto Yield Farming
Yield farming is the practice of lending out cryptocurrencies and getting paid in interest or fees in return. It resembles in some ways an operation known in the stock market as share lending.
It’s a way for cryptocurrency investors to generate additional income or “yield” from their virtual coin holdings, in addition to waiting for the value of the asset to appreciate and generate returns. Risks however include theft and market manipulation.
Yield farming is one of the practices that has come out of the Decentralized Finance (DeFi) movement. A guide to DeFi: it aims to build a decentralized ecosystem of financial products and services so that consumers move away from traditional financial institutions.
Yield farming involves liquidity pools–markets where cryptocurrency owners supply their assets and from where borrowers can pull. Those interested in yield farming can access a liquidity pool through dapps, or decentralizations applications.
Borrowers may use the rented cryptocurrencies for speculative purposes, and interest rates tend to vary depending on the demand for the virtual coin.
The Takeaway
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 investment 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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