What Is Average Annual Yield?
The average yield on an investment or a portfolio is the sum of all interest, dividends, or other income that the investment generates, divided by the age of the investment or length of time the investor has held it. In particular, it’s the yield, or total income generated from an investment, divided by the number of years held.
- The average annual yield is the income received from an investment divided by the length of time the investment is owned.
- An average annual yield is a beneficial tool for analyzing the return on floating-rate investments.
- Popular versions of average annual yields include annual percentage yield, seven-day yield, tax-equivalent yield, and stock dividend yield.
How Average Annual Yield Works
The average annual yield is a particularly useful tool for floating-rate investments, in which the fund's balance and/or the interest rate change frequently. The average annual yield can also apply to a range of other investments, from deposit accounts, stocks, commodities, and/or real estate.
The average annual yield is a backward-looking measurement and can also be very useful in determining the actual performance of a mixture of investments. In general, the average annual yield will determine performance over time on any multi-year investment.
For example, for a savings account that pays a floating rate of interest on balances, the average yield can be calculated by adding all interest payments for the year and dividing that number by the average balance for the year.
Average annual yield is often beneficial to assess a portfolio of mixed investments.
Types of Average Annual Yield
There are a variety of yield measurements that apply to many fixed income and money market securities. For example, the annual percentage yield or APY measures an investment’s effective annual rate of return, taking into account the effect of compounding interest and assuming a full 365 holding period. A seven-day yield is the annualized yield for a money market mutual fund, calculated based on the fund’s average seven-day distribution.
For bonds, common yield terms include the current yield, which is a bond’s interest rate as a percentage of its current price. The yield to maturity or YTM estimates what an investor will receive if she held the bond to its maturity date. A tax-equivalent (TE) yield also refers to many non-taxable municipal bonds. The tax-equivalent yield fairly compares the yield of a tax-free bond to that of a taxable bond and is also known as after-tax yield.
Dividend-paying stocks also have a variety of yield measurements or stock dividend yields. The yield on cost, for example, is a security’s annual dividend rate, divided by its average cost basis. Many companies, particularly older and more stable ones, pay out a portion of their earnings as dividends. Investors who seek out high yields for retirement income seek out and regularly calculate these yields. At times yields may become too high, however, implying that a company is over-extending itself.
Example of Average Annual Yield
Say that an investor owns a portfolio of stocks, where they generate a return of $1,000 on a $10,000 net valuation during year one. Then, the return is $1,500 on the same investment amount in year two, and $800 on the same investment in year three.
The return on year one was thus 10%, 15% in year two, and 8% in year three. The investor’s average annual yield is 11%, or ((10% + 15% + 8%) / 3).