What is yield?
Yield is the amount of income generated by an investment, expressed as a percentage of the investment value.
At the most basic, an investment’s yield is the amount of income it generates in a year divided by its total cost.
Investment Cost: $10,000
Annual Interest Earned: $500
Annual Yield: $500 / $10,000 = 5%
Investors want to ensure they put their money to the best possible use. Yield calculations are used to compare different investment options to see which ones will be the most profitable.
Yield vs. Return
Yield and return are both expressions of investment income, but yield is used to predict how profitable an investment will be in the future, while return calculations are retrospective.
Yield vs Return
|Estimate of income that will be earned||Accurate calculation of income that has already been earned|
|Based on assumptions||Based on historical data|
Types of yield
There are many types of yield calculations that use different information to predict the return of different types of investments.
Some yield calculations take into account the power of compounding, assuming the investor reinvests all proceeds from the investment, which can make them very complex.
|Yield to Maturity
Yield and risk
Generally, riskier investments have higher yields. For example, a bond issued by a struggling company will carry a higher coupon rate than one issued by the U.S. government because investors need to be compensated for the increased risk of default.
Similarly, an investor looking for higher yields might invest in a new tech company rather than an established retailer. While the retailer’s stock is not likely to lose much value—making it a low-risk investment—most of the company’s big growth is behind it. The new tech company is likely to fail, which makes it risky, but if the company does well, a small high-risk investment now could be a huge moneymaker in a few short years.
- So-called “junk bonds” have such a high risk of default that they carry very high coupon rates and some of the highest yields available.