Yield refers to what an investment will earn for its holder over a particular period of time such as through dividends or interest in addition to what might be gained by the security rising in value. Securing strong yield is a high priority for those whose income derives primarily from their investment assets, rather than through their earnings, and so is a perennially hot topic for retirees.
Yield is expressed as a percentage, its calculation being the net realised return divided by the original amount or “principal” that was invested. So, for instance, if you were to purchase a FTSE 100 stock for £100 then sell it a year later for £130 after having enjoyed an annual dividend of £5, your yield would be 35% (£30+£5 / £100). Similarly, if you bought a UK government bond for £1,000 which paid a 3% annual coupon, your yield would be 3% (£30 / £1,000).
There are various ways in which yield is calculated for both stocks and bonds. For stocks, you may see yield on cost (which is where the security’s original price is taken) or elsewhere current yield (which looks at current share price). For bonds, nominal yield is one measure, which is usually calculated on an annual basis by dividing the annual coupon by its face value, but there is also yield to maturity, which is the average yield you can expect per year holding the bond to the end of its term. Yield to worst, where the earliest that an issuer could have to repay the principle is considered, is another.
Yields is a useful measure that can tell investors a lot about the risk-return profile of investments, but heed must be taken of the calculations that have been made and the reasons behind the numbers. On the face of it, high yield value may seem like an unmitigated good, but not if this is down to the value of the security falling or a company paying out unreasonably high dividends to keep investors on board as its stock price plummets. Sharp upticks in yield that can’t be well justified should prompt questions – as should stellar yield numbers generally. Higher reward invariably means higher risk.
Yield is an incredibly important concept in managing investments and financial planning. It can tell investors a lot about the risk-return profile of a particular security and is vital for investors whose income is derived from their investment assets rather than other revenue streams, like retirees. Yield comes in many forms, however, and investors need to understand why a particular calculation methodology is deployed and what is making the numbers change if comparisons are to be meaningful. Higher yield may not always be a good thing.