A yield is a percentage measure of income you can earn from your investments in a given time. If you're a passive-income investor, you may live entirely or partially on your investment's proceeds or hope to do so in the future. In that case, understanding what yield is, how to calculate it and how it differs from returns can help you make the most of your income-focused portfolio.
By helping you figure out the worth of an investment over a specific period, yield enables you to compare diverse investment options. You're more likely to choose options that align with your portfolio while avoiding yield traps. A constructive understanding of yields is equally essential for the growth investors willing to weather the market downturn to meet their long-term goals. Let's face it, the core objective of investing is to make money whether the money is used for shopping, vacations, utility bill payments, to pay off an emergency or for reinvestment.
While it's vital that you know how yield works, you must remember that your goals and risk appetite play a crucial role in determining your investment earnings. Whether you're a beginner or an experienced investor, this article provides a simplified explanation of yield, how it impacts your portfolio and potential low-risk and high-yield investments that can help turbocharge your portfolio.
What is Yield?
Yield is the percentage of income or earnings from your investment over a set period. Yield excludes profits from an increase in the price of your initial investment, referred to as capital gains. By calculating yield, you can quickly tell your annual earnings relative to your investment's initial cost and market value. It's possible to conflate yield with return on investment (ROI) since both are earnings from your investment.
However, both significantly differ. Yield is specific to income and excludes capital gain. It is a prospective percentage measure, which gives you an idea of what earnings to expect. You can imagine yield as a cash flow that occurs alongside, for instance, stock price appreciation. It, therefore, represents only a portion of your total investment returns. In contrast, ROI considers all investment gains made over a set timeframe. This encompasses income (e.g., dividends or interest) and capital gains.
ROI reflects the dollar amount you earn or lose from your investment over time. Unlike yield, which is a prospective measure and so relatively unpredictable, ROI is a retrospective measure, meaning it only considers what happened in the past. You should consider both ROI and yield when assessing your portfolio to get a better picture of the overall health of your investment.
How Do You Calculate Yield?
You can calculate your investment yield by dividing your income (dividend or interest) over a set timeframe by either its current price or your principal. However, the specific parameters used in the calculation are determined by what your investment relates to. There are primarily three yield types.
Dividend Yield (Stock)
When it comes to stock, the income that stockholders receive is in the form of dividends. The frequency of the dividend varies among companies. However, it is typically quarterly, although it can also be monthly, semiannually or annually. To calculate dividend yield, divide the dividend per share by the current stock price and multiply by 100. Let's consider a practical example:
Suppose a company ABC pays investors $2.00 in annual dividends; if its current stock price is $50.00, then (a) calculate the dividend yield, (b) assuming the annual dividend and price remains unchanged, calculate how much an investor will earn in annual dividend for buying $5,000 worth of stocks (c) assuming the annual dividend remains unchanged, calculate the dividend yield if the stock price increase rises to $70 (d) assuming the annual dividend remains unchanged, calculate the dividend yield if price drops to $30 (e) calculate the dividend yield if the price remains unchanged and the company now pays 0.375 quarterly dividends.
Answer:
Dividend yield = Dividend per share (or annual dividend) / stock price * 100
- Dividend Yield (D.Y.) = Annual Dividend (A.D.) / Stock Price (S.P.) * 100
D.Y. =( $2 / $50 )* 100 = 0.04 * 100 = 4%
- By investing $5,000, the investor will earn an annual dividend equal to 4% of $5,000 = 0.04 * $5,000 = $200
- For a price rise to $70, D.Y. = ($2 / $70) * 100 = 2.86%
- For a price drop to $30, D.Y. = ($2/$30) * 100 = 6.67%
- For a quarterly dividend of 0.375, the annual dividends = 4 * 0.375 = $1.5. Therefore, D.Y. = ($1.5/$50) * 100 = 3%
A key take here is that dividend yields decrease with increasing share or stock price and increase with decreasing stock value. So a high yield may not readily translate to profitable investment, and you must carry out due diligence to avoid falling prey to yield traps. Dividend yields for the S&P 500 have historically ranged between 3% to 5%.
Interest Yield (Bond)
Bonds are another common type of yield-producing investment. If you invest in bonds, you'll receive income or yield in the form of a coupon payment, which is often paid semiannually (although it can vary). To calculate your bond interest yield, divide the coupon price by the bond price and multiply by 100.
For instance, suppose you purchased big bank bonds at a price tag of $102.51 to help you earn a fixed income during retirement. If the coupon is 5.25%, you can calculate your interest or bond yield as follows:
First, multiply the coupon percentage by 100 to get the bond per year and then apply the formula:
5.25% = 0.0525 * 100 = $5.25 per bond per year
Interest yield = coupon price/bond price * 100
Interest yield = ($5.25 / $102.51) * 100 = 5.12%
Like dividend yield, interest yield moves inversely to bond price. Bonds with high yields, often referred to as "junk bonds," have greater risk and are more prone to defaults. However, such bonds also have strong profit potential.
Rental Income Yield (Real Estate)
As a real estate investor, the yield on your rental property can tell you how much income your real estate investment will potentially generate after accounting for operating expenses (property tax, maintenance charges). It is often referred to as the capitalization rate. To calculate the yield, divide the net rental income by your real estate value and multiply by 100.
That is: Rental income yield = Net rental income / real estate value * 100
For instance, suppose you purchase a bedroom apartment unit at $625,000 and rent it out at $2,450 per month to earn some extra income. Assume your monthly expenses (tax, insurance, maintenance charges, etc.) amounts to $975. You can calculate your yield or capitalization rate thus:
Net monthly income = $2,450 - $975 = $1,475
Net annual income = $1,475 * 12 = $17,700
Rental income yield = ($17,700 / $625,000) * 100 = 2.832%
Low Risk Investment Strategies
High-yield investments offer you a shot at financial security, providing you with the passive income needed to finance your everyday activities. Various high-yield assets or investment opportunities exist, from low-risk options like savings accounts and CDs to moderate-risk alternatives like corporate bonds or high-risk options like stocks. Benzinga takes a deep dive into these investment options.
High-Yield Savings Accounts
Depositing your money into a high-yield savings account is one of the safest approaches to investing. The reason is that such deposits are guaranteed by the Federal Deposit Insurance Corporation (FDIC). The FDIC offers up to $250,000 in coverage per insured bank account in the event of insolvency or bank failures. Your cash stays safe even if the financial institution fails. Its low-risk, high-yield savings accounts allow you to earn interest on your investments while minimizing the inflationary impact on your hard-earned dollars.
You can start small, adding an incremental sum monthly and watch it grow over time. You can increase your balance by earning interest on your deposit in the account. Historically, interest rates have ranged between 3% to 5%. Recent rate hikes by the Fed and the potential for more to halt run-away inflation means you can earn more from your high-yield savings account. The reason is that rate hikes benefit savings account holders, unlike borrowers.
Certificate of Deposits (CDs)
Certificates of deposits (CDs) are another excellent financial instrument for savings and investing for risk-averse investors looking to earn moderate to high yields. Compared to high-yield savings accounts and money-market, CDs offer somewhat higher interest. However, in exchange for that level of interest, investors are required to lock their capital for an agreed-upon timeframe which often ranges between three months to several years.
Withdrawal before maturity attracts penalties, so you must consider that when investing in CDs. Like high-yield saving accounts, CDs created at FDIC-insured banks are insured, guaranteeing the safety of your investments. While CDs guarantee investors upfront payment at the maturity date, interest over the course of its term is relatively low compared to other investment options available.
Treasuries and Other Bond Types
Treasuries are bonds issued by the U.S. government to fund government expenditures, funding social security benefits and more. Bonds are a loan issued by a government or corporation to raise funds. And as a loan type, bonds are repayable with interest to investors. Treasuries are considered the most predictable and safest type of bond since they're backed by the full faith and credit of the U.S. government.
They're often used as a proxy for the economy's "risk-free" rate of return. State and local governments also issue bonds referred to as municipal bonds, which offer low-to-moderate risk but better interest than Treasuries. Corporate bonds issued by corporations provide the best interest but are considered high risk because of the possibility of default. A default occurs when a bond issuer or borrower cannot pay at maturity. For all bond types, investors receive their principal plus interest at maturity. Sometimes, the interest is paid semiannually.
The time duration for maturity depends on the specified terms and may range between one year (for short-term bonds) to decades (for long-term bonds). You can invest in bonds directly or gain indirect exposure via bond funds. Despite being less volatile than stocks, bonds are still susceptible to inflation. However, if you want a more robust hedge against inflation, you can leverage Treasury Inflation-Protected Securities.
Stocks
Stock remains the best high-yield, high returns investment option for income and growth investors. The average return of the S&P 500 for the past 10 years (from 2012 to 2021) is 14.83% (12.37% when adjusted for inflation). While it may perform lower, the average reflects the fact that, overall, the stock market offers the potential for a great return.
When you invest in a stock, you're betting on the company to grow and perform well in the future. When this happens, the stock of the company appreciates, enabling you to reap optimum returns and yields. However, there's no guarantee that the market will move in your favor. This fact makes stock market investing a high-risk activity. You can minimize risk by investing in the stock of well-established companies.
You can invest in growth stocks, which are stocks of growth-oriented businesses that seek capital appreciation as their core goal. This strategy can work well if you're a long-term investor focused on a company’s future potential. If your strategy is short-term gains or passive-income focused, you can invest in dividend stocks. This strategy presents a good way to put hard dollars from your stock investments into your pocket. You must understand that companies may slash dividends in times of economic uncertainty.
Index Funds and ETFs
Index funds and ETFs can offer low-risk, high-yield, high-return investments. Both are baskets of securities or asset classes (stocks, bonds, dividends) that track specific indexes and allow investors to gain indirect exposure to diverse assets, including alternative asset classes like precious metals and commodities.
They're especially useful in portfolio diversification. Diversification protects your investment against volatility resulting from a turbulent economy. A disaster can befall an individual company that impacts its stocks and hurts investors. However, when you hold stocks of different companies, you aim to spread your risk more evenly and avoid torpedoing your portfolio.
Index funds and ETFs are efficient, low-cost, low-risk and potentially high-reward approaches to building long-term wealth.
What to Consider with High Yield Investments
Some factors worth considering are:
Risk
Like every other investment, you must consider the risk potential and make decisions based on your risk appetite. High-yield savings accounts, CDs and Treasuries offer low risk. In comparison, municipal bonds, ETFs and index funds offer medium risk. Corporate bonds and individual company stocks represent higher risk.
Strategies
Are you a short-term, income-focused investor looking for passive income for everyday activities? If so, you should prioritize dividend-paying stocks and high-yield but low-risk bonds. If you're a long-term investor focused on future growth, you can go for stocks of companies with promising prospects for future growth or long-term bonds. If you want to hedge against an inflationary or deflationary economy, Treasury Inflation-Protected Securities could be your best bet.
Liquidity
Whether you're a growth or income investor, you'll like to sell the asset at some point, and how quickly you can convert it into cash without losses determines its liquidity. Bonds and bond funds are relatively liquid compared to stock because you'll potentially lose by selling stocks at the wrong time. Most other investment options, including real estate, are illiquid.
Ex-Dividend Dates
An ex-dividend date is a crucial date in the world of investing. It is the date on which a stock begins trading without the value of its upcoming dividend payment. This means that if an investor purchases a stock on or after the ex-dividend date, they will not receive the upcoming dividend payment. Conversely, if an investor owns the stock before the ex-dividend date, they will receive the dividend payment. The ex-dividend date is typically set by the stock exchange where the stock is traded, and it is usually set two business days before the record date, which is the date on which a company finalizes its list of shareholders who are eligible to receive the dividend.
The ex-dividend date is important for both investors and companies. For investors, the ex-dividend date determines whether they will receive a dividend payment or not. For companies, the ex-dividend date helps them ensure that they pay dividends only to current shareholders. Additionally, companies often use the ex-dividend date as an indicator of the health of their business. If a company is regularly paying dividends, it may indicate that the company is financially stable and generating strong profits. On the other hand, if a company stops paying dividends, it may be a red flag that the company is struggling financially. Overall, the ex-dividend date is an essential element of the dividend payment process and an important consideration for both investors and companies alike.
Frequently Asked Questions
What is meant by the U.S. yield?
The U.S. yield is the effective annual interest the U.S. federal government pays its lenders or investors it borrowed money from via bond issuance.
Does a high yield imply a high price?
No, the yield has an inverse relationship with the asset price, meaning it goes up when the asset price declines. Therefore, yield doesn’t provide a comprehensive picture of asset income. ROI paints a more constructive picture of an asset’s income as it includes capital gain or loss in its calculation.