People often use yield and return interchangeably, referring to what you'll earn from the fixed investment. However, there are some essential differences to note for yield vs return. Learn the basics of these two fundamental concepts, plus some key differences to consider when looking at each of them.
The terms yield and return are often used interchangeably, but they do have notable differences. The primary consideration between the two is the time they analyze. Learning about this difference, and others can help you make more informed investment choices. In this article, we define both returns and yields, list and explain the differences between the two terms and offer examples and calculations of both.
It's easy to see how an investor might confuse yield and return. After all, both refer to the income earned on an investment. But there are several distinctions between the two. Yield refers to income earned on an investment, while its return references what an investor gained or lost on that investment. Yield expresses itself as a percentage, while the return is a dollar amount.
An investment's yield is a more forward-looking assessment. As a result, it represents what an investor stands to gain (or lose) on that investment. Yield takes into account current market value and face value but does not factor in capital gains. Meanwhile, its percentage is typically an annual percentage rate (APR). As with any investment, the higher the risk, the higher the potential yield.
Alternately, an investment's return focuses on the dollar amount of what an investment has earned in the past. Return focuses on paid dividends or annual payments made to stock owners or investors by the company. It also looks at capital gains, which is the increase in the value of an asset. Capital gains can both be short and long-term.
Do not confuse yield with a rate of return. Both are percentages that anticipate an investment's expected return over time. However, the rate of return takes into account capital gains, and yield does not.
The primary purpose of most bond funds is to provide investors with income. But those who focus exclusively on a bond fund's yield are only seeing part of the picture. Investors must also consider the fund's total return, which is the combination of yield and the return provided by principal fluctuation.
What Is The Return?
Return, also known as financial return, is the money earned or lost due to the performance of an investment over some time. Returns are often expressed in dollar value of investments over time and as a percentage from the profit to investment ratio.
Additionally, some returns present as net results or gross returns that only account for the price.
Of course, XYZ's share price likely changed over that same time, which is where the return can be helpful. Return is a measure of an investment's total interest, dividends and capital gains, expressed as a financial gain or loss over a specific timeframe.
When assessing an investment, return provides a glimpse of the investment's prior performance and helps determine if a particular investment has been profitable over time. If stock XYZ ended the year at $55 per share, your total return would be equal to the increase in share price plus the dividends, or $700 ($5 + $2 = $7 x 100 shares). That same $5,000 investment returned 14 percent ($700 / $5,000 x 100).
What Is Yield?
Yield refers to how much income an investment generates, separate from the principle. It's commonly used to refer to interest payments an investor receives on a bond or dividend payments on a stock.
Yield is often expressed as a percentage rate, based on either the investment's market value or purchase price. For example, imagine bond A has a $1,000 face value and pays a semiannual coupon of $10. Over one year, bond A yields $20, or 2 percent. This is known as the cost yield because it's based on the cost or value of the bond.
However, most people buy bonds on the secondary market and not directly from the issuer, meaning they pay more or less than face value. If you are considering purchasing the same bond A for $900, the $20 coupon payments based on the current $900 price would be a yield of 2.2 percent for you. This is known as the current yield because it's based on the current price of the bond.
Yield is also a commonly used term when discussing dividend stocks. For instance, say you purchase 100 shares of XYZ for $50 ($5,000 total). Each quarter, XYZ pays a dividend of 50 cents per share. Over a year, you would receive $200 in dividend income (50 cents x 4 quarters = $2 x 100 shares). Your initial investment of $5,000 yielded 4 percent ($200 / $5,000 x 100).
Bond Yield vs. Return
Yield is the income that a fund pays on either a monthly or quarterly basis. The investor can either take this income in the form of a check or reinvest it back into the fund to buy new shares.
There are various ways to calculate yield, which can be a source of confusion for many investors. The bottom line is that if a fund's share price didn't change and it paid a 5% yield in a given year, the fund's total return would be 5% for that year.
Unfortunately, it doesn't always work that way in real life. In addition to the return provided by yield, the daily fluctuations in the share price (or "net asset value") also contribute to total return.
In a given year, these fluctuations can cause the total return to be higher or lower than the fund's yield. If a fund that yields 5% also has a 5% increase in its share price, its total return is 10%. If the same fund experiences a 5% decline in its share price, the total return is 0%.
Depending on the type of fund, these fluctuations can have varying degrees of impact on return. For instance, high-yield and emerging market bond funds tend to have much greater volatility than short-term bond funds that invest in higher-quality securities. Before investing in a fund, investors need to be sure they are comfortable with the potential volatility.
While a fund that invests in high yield bonds will usually have a higher yield than another bond fund that invests in higher-quality securities, the amount of principal fluctuation may not be appropriate for investors with low-risk tolerance or who may need the money shortly.
Those who have struggled to grow their money in the low-interest-rate environment over the past decade have mainly been retirees and others who invest for income. Money market interest continues to be virtually non-existent and yields on other traditional income vehicles, such as CDs, remain low. As these investors seek ways to meet their income needs, it is helpful for them to understand the concepts of both yield and total return.
Yield and return look similar, but they are different. Most people think the two terms to be the same.
When talking of return, it is what an investor has earned on his investment during a certain period during the past. Return generally takes into account interest, capital gain, an increase of share price and dividends. Return can be called as retrospective or what one has earned in the past.
In contrast to Return, Yield is prospective or advanced looking. Yield measures income like interest and dividends that are earned through an investment ignoring capital gain. In yield, the income is taken in the perspective of a certain period of time and then annualized, with the supposition that the dividends and interests will continue to be obtained at the same rate.
When yield can be called as a percentage increase on investments, the return can be called an absolute dollar amount. Yield usually refers to the annualized number, whereas return refers to any period of investment, may be one year or two years.
Return can also be said to be the overall change in value with the assumption that the fund's dividends and capital gains are reinvested. On the other hand, yield depicts the income and earnings of funds on its investments. Unlike return, yield is the measure of income and not capital gains.
When talking of bonds, a return is an interest payment on principle. Yield denotes the price of the bond.
The yield of an investment is the income it earns. An investment usually expresses its yield as a percentage. For example, the interest or dividends security produces over a certain period can be its yield. The yield of investment uses the investment's face value, or what an investor originally paid for a stock. Also, yield factors in an investment's liquidity, or its current market value.
An investment's return, however, is the dollar amount an investment earns or loses over time. An investment's return also accounts for dividends earned, interest earned, and capital gains.
Yield isn't as predictable as a return. However, sometimes investors can anticipate yield, depending on the security and its predictability.
Return is the financial gain or loss on an investment and is typically expressed as the change in dollar value of an investment over time. Return is also referred to as total return and describes what an investor earned from an investment during a certain period. Total return includes interest, dividends, and capital gain, such as an increase in the share price. In other words, a return is a retrospective or backward-looking.
For example, if an investor bought a stock for $50 and sold it for $60, the return would be $10. If the company paid a dividend of $1 during the time the stock was held, the total return would be $11, including the capital gain and dividend. A positive return is a profit on an investment, and a negative return is a loss on an investment.
Yield is the income returned on an investment, such as the interest received from holding the security. The yield is usually expressed as an annual percentage rate based on the investment's cost, current market value, or face value. Yield may be considered known or anticipated depending on the security in question, as certain securities may experience fluctuations in value.
Yield is forward-looking. Furthermore, it measures the income, such as interest and dividends, that an investment earns and ignores capital gains. This income is taken in the context of a specific period. It is then annualized with the assumption that the interest or dividends will continue to be received at the same rate.
A bond yield can have multiple yield options depending on the exact nature of the investment. The coupon is the bond interest rate fixed at issuance, and the coupon rate is the yield paid by fixed-income security. The coupon rate is the annual coupon payments paid by the issuer relative to the bond's face or par value.
The current yield is the bond interest rate as a percentage of the current price of the bond. The yield to maturity is an estimate of what an investor will receive if the bond is held to its maturity date.
Rate of return and yield describes the performance of investments over a set period (typically one year), but they have subtle and sometimes important differences. The rate of return is a specific way of expressing the total return on an investment that shows the percentage increase over the initial investment cost. Yield shows how much income has been returned from an investment based on initial cost, but it does not include capital gains in its calculation.
Rate of return can be applied to nearly any investment while yield is somewhat more limited because not all investments produce interest or dividends. Mutual funds, stocks, and bonds are three common types of securities that have both rates of return and yields.
The formula for rate of return is:
Current Price - Original Price/Original Price times 100
Current Price − Original Price ×100
In our earlier example, if a stock is bought for $50 and sold for $60, your return would be $10 for the investment. Adding the dividend of $1 during the time the stock was held, the total return is $11, including the capital gain and dividend.
The rate of return is:
$60(Current Price) + $1(D) − $50(Original Price)
=22% Rate of Return
D = Dividend
Consider a mutual fund, for example. Its rate of return can be calculated by taking the total interest and dividends paid and combining them with the current share price, then dividing that figure by the initial investment cost. The yield would refer to the interest and dividend income earned on the fund but not the increase—or decrease—in the share price.
There are several different types of yield for each bond: coupon rate, current yield, and yield to maturity. Yield can also be less precise than the rate of return since it is often forward-looking, whereas the rate of return is backward-looking. Many types of annual yields are based on future assumptions that current income will continue to be earned at the same rate.
Using Yield And Return Together
Yield and return should be used together to help you evaluate an investment's overall performance.
Consider the earlier example of stock XYZ. Let's say XYZ shares lost value over the year and are now valued at $45 each. The total return for that investment would be negative; you would have lost $300, or 6 percent ($200 in dividends – $500 in principal). However, the yield didn't change. You still received $200 in dividend income.
Investing in stocks based on their yield could prevent you from having to sell shares to generate income. In a market downturn, this can help you avoid selling shares at a loss.
Return can be used to assess not only individual investments, but also an entire portfolio to determine the overall performance and pinpoint whether certain underperforming investments should be sold, and the money reinvested elsewhere.
Investors need to take care not to confuse yield with the total return. Just because a fund has a reported yield of 7% doesn't mean that's the actual return on your investment. In a given year, fluctuations in the bond fund's share price, the fund's capital gains distribution to its shareholders, and the particulars of your own tax situation mean that your after-tax return will likely differ.
The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.
Risk is an essential consideration for an investment's yield because high-yield investments may carry more risk.
For instance, if company B wants to sell bonds, but investors think company B is at risk of missing coupon payments and going bankrupt, the company likely needs to pay a higher yield on those bonds to compensate for the trouble. To assess the risk of a bond in comparison to its yield, investors often look at the bond's rating. It's no surprise that the lowest-rated debt usually has the highest yield. In fact, the term "high-yield" and "junk" are often used interchangeably when discussing poorly rated obligation.
With stocks, if a company is paying high dividends, it may not be reinvested in the company and growth, which could jeopardize the investment long term. It's essential to look at how the dividend payments fit into the company's overall financials. If, for instance, the company consistently reports negative earnings (i.e., losing money) but is still paying dividends, it may be tapping into cash on hand or other sources to afford those payments. This could signal long-term problems or even future elimination of dividends.
Investors should consider their investment goals and tolerance for risk when determining if an investment is a right fit for their portfolio. And once you're ready to pull income from your investments, consider making an appointment with a financial professional to assess your goals and help make sure your withdrawal plans are aligned with your investment objectives.