Yield

A yield is the income an investment produces, stated as a percentage of its price. The general form is the same everywhere: take what the holding pays out over a year, divide it by what it costs or by what it is currently worth, and express the result as a percentage. A $50 stock paying $2.00 a year in dividends yields 4%; a $1,000 bond paying $40 a year in interest yields 4% of its face value.

Explaining the naming matters here more than usual, because the word is used more loosely than any other measure on a statement. The SEC's investor glossary defines "yield" narrowly, as "the annual percentage rate of return earned on a bond calculated by dividing the coupon interest rate by its purchase price," and separately defines "current yield" in nearly the same terms. Both entries are about bonds. In practice the word travels much further than that: banks quote an annual percentage yield on deposits, stocks are described by dividend yield, funds quote yields computed under SEC formulas, and analysts speak of an earnings yield. They are all ratios of income to price, and they are not interchangeable.

The differences between the measures are differences in what counts as income and what sits in the denominator. A bank's annual percentage yield counts interest and the effect of compounding over a year, measured against the deposit balance. A dividend yield counts declared dividends only, measured against the share price. A bond's current yield counts the coupon interest only, measured against what was paid or what the bond now trades for. A fund's quoted yield is computed under a formula the SEC prescribes rather than by any of these simple divisions. So four investments can each be described as yielding 4% while making four different statements, and none of them is being deceptive.

The most consequential thing a yield leaves out is the value of the holding itself. Income arriving on schedule and the price of the thing producing it are separate facts, and a yield reports only the first. That is why a yield should not be read as a return: a holding can pay 4% of its value during a year in which its price falls 6%, and the yield was accurate the whole time. The measure that puts both halves together is total return, and any comparison between investments that differ in how much of their result arrives as income has to be made there rather than here.

Yield to maturity is the exception worth naming, so the rule is not overstated. It is a yield in the sense that it is expressed as an annual percentage, but it accounts for the difference between the price paid and the amount repaid at the end as well as the interest along the way. The family of bond yield measures, and the assumptions built into that one in particular, are set out under the bond yield.

A high yield is a fact about a ratio, and ratios have two sides. Because price sits in the denominator, a yield rises when the payment goes up and also when the price goes down, and the figure alone does not say which happened. This is the reason a screen sorted by highest yield is not a list of the best investments; the dividend yield covers the equity version of this problem in detail. The general habit worth forming is to ask what changed to produce the number before treating a higher yield as better.

Take the annual income, divide by the relevant price, multiply by 100. What varies between measures is which income and which price, so the useful step is always to name the measure before comparing anything.

A hypothetical example of three investments described identically. Colm has $25,000 to place, and three options are each presented as yielding 4%. On that amount, 4% is $1,000 a year in every case, and there the similarity ends.

In a savings account at a 4.00% annual percentage yield, he receives about $1,000 over the year, the figure already accounts for compounding, and the balance itself does not move with markets. In a portfolio of dividend-paying stocks with a 4% dividend yield, he receives about $1,000 in dividends, and the $25,000 can be worth considerably more or less at the end of the year. In a bond fund quoting a 4% yield, he receives about $1,000 in distributions, and the fund's share price moves in the meantime.

Same headline number, same dollar income, three different exposures of the $25,000 that produced it. If the stock portfolio fell 10% over the year, its total return would be about −6%: the $1,000 of dividends against a $2,500 decline in value. The yield was correct and told him almost nothing about that outcome.

Pros

• Expresses income on a per-dollar basis, so investments of different sizes can be compared on what they pay.
• Directly useful for anyone spending the income, since it estimates the cash a holding will generate.
• Deposit yields are standardized by rule, which makes bank comparisons genuinely like-for-like.
• A yield is simple to compute and to check by hand from figures that are published.

Cons

• It is not a return. Any change in the value of the holding is outside the measure entirely.
• The same word names different computations across deposits, bonds, stocks and funds, so two quoted yields may not be comparable.
• Because price is the denominator, a yield rises when the price falls, and the figure cannot distinguish a raised payment from a falling price.
• Quoted yields are backward-looking or based on current payments, neither of which is a commitment to keep paying.