Yield vs. Return: An Overview
Yield and return are two different ways of measuring the profitability of an investment over a set period of time, often annually. The yield is the income the investment returns over time, typically expressed as a percentage, while the return is the amount that was gained or lost on an investment over time, usually expressed as a dollar value.
- Yield and return both measure an investment's financial value over a set period of time, but do it using different metrics.
- Yield is the amount an investment earns during a time period, usually reflected as a percentage.
- Return is how much an investment earns or loses over time, reflected as the difference in the holding's dollar value.
- The yield is forward-looking and the return is backward-looking.
Yield is the income returned on an investment, such as the interest received from holding a 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 and 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.
Return is the financial gain or loss on an investment and is typically expressed as the change in the dollar value of an investment over time. Return is also referred to as total return and expresses 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 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.
Risk and Yield
Risk is an important component of the yield paid on an investment. The higher the risk, the higher the associated yield potential. Some investments are less risky than others. For example, U.S. Treasuries carry less risk than stocks. Since stocks are considered to carry a higher risk than bonds, stocks typically have a higher yield potential to compensate investors for the added risk.
The rate of return is a metric that can be used to measure a variety of financial instruments, while yield refers to a narrower group of investments—namely, those that produce interest or dividends.
The Rate of Return vs. Yield
Rate of return and yield both describe 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:
Original PriceCurrent 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:
$50$60(Current Price) + $1(D) − $50(Original Price)=0.22∗100=22% Rate of Returnwhere: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.