The Difference Between Investment Yield and Return

Yield vs return - what really is the difference between yield and return? After all, aren’t these terms almost used synonymously for one another? 

Well, yes, they are. Many people, including experienced investors, may use these terms interchangeably. And while using them interchangeably is not the end of the world, it is not accurate either. Each term has its own meaning, its own purpose, and understanding that distinction can make a big difference in how you select your investments. 

So no, it is not really a potato-potahto situation.

If you have ever wondered what these words actually represent and why they are used so specifically, you are in the right place. Let's break down the difference between yield and return in this article.  

What is the meaning of yield in finance?

Yield is nothing but the income you earn from an investment. This could be earned from interest, dividends, or other payouts. However, unlike total return, yield is not linked to the investment's price. So, it does not matter whether the price of your investment goes up or down. The yield focuses only on what you earn along the way. That is why the metric is most often used by investors when they are comparing bonds, dividend stocks, and other similar funds that provide regular income. 

Yield is usually shown as a percentage. The yield percentage tells you how much income you are earning relative to the value of your investment. So, the yield could be equivalent to the price you originally paid for the investment and to the price the investment is currently trading at.

How can you calculate yield?

Here are two examples that can help you understand how to calculate yield for a specific asset:

Let's start with a simple bond example.  

Let's say you buy a bond with a face value of $5,000. This bond pays you $150 in interest every year. If you buy it directly from the issuer at $5,000, your yield would be $150 divided by $5,000, or 3%. This is the coupon yield. It is fixed from the day the bond is created, and does not change, no matter what happens in the market afterwards.

But most of the time, people buy bonds in the secondary market, where prices move around. So, you may purchase the same bond for $4,500 instead of $5,000. Even if you buy it at a lower price, you are still earning the same $150 in interest each year. So, it seems your yield is higher, and it is, given the investment value, even though it is still the same at $150. But when you divide $150 by $4,500, you get roughly 3.33%. Now, this is more than when you earned 3% on the $5,000 bond, making the investment more attractive.

Now let's talk about dividend stocks.  

Imagine you buy 200 shares of a company at $50 each, so your total investment is $10,000. This company pays a quarterly dividend of 50 cents per share. Over a year, that comes to $2 per share, or $400 in total dividends. When you divide $400 by your $10,000 investment, you get a dividend yield of 4%. 

What is return?

Unlike yield, return takes a cumulative view of your earnings. The yield only considers the income you receive. The rate of return, on the other hand, includes any interest or dividends you earn along the way plus the change in the investment's value. So, basically, if you purchase a stock that appreciates over time and gives you a dividend, the rate of return would include both of these. So, your total gain would not just be from the price going up. It would also include the dividends. Add both to get your total returns.

The rate of return considers only two aspects – the amount of money you invested at the beginning and the amount you redeem at the end. The rate of return shows you your total gain or loss over a specific period, and is usually expressed as a percentage. 

As you may have guessed, if the final value of your investment is higher than what you put in, your rate of return will be positive, and you will have made a profit. If it ended up lower, the return would be negative, and you would have incurred a loss. 

You can calculate the rate of return for almost anything, including stocks, bonds, mutual funds, real estate, or even your savings account. It is often used to compare two or more investments side by side. You can do this when selecting new investments or when measuring the performance of your investments within your portfolio. Say you invested in two stocks at the same time. Comparing their five-year rates of return will help you understand how each stock has performed and which is running the show.  

How can you calculate the rate of return?

Let's say you invested $5,000 in a stock at the beginning of the year. You bought 100 shares at $50 each. By the end of the year, the stock price increases to $55. Hence, you get a $5 gain per share, or $500 in total price appreciation. Now imagine the company also paid you $1 per share in dividends over the year. That is another $100 in income.

So, your total gain is not just from the price going up. It also includes the dividends. Add both, and you have a total of $600 in returns ($500 from the price increase plus $100 in dividends). When you divide the total return by your original investment, you get a 12% return for the year. This is your profit from the investment. 

Now, if the stock price had dropped and the company offered no dividends, your rate of return could easily end up negative. In this case, you would have incurred a loss. 

Yield vs rate of return – What are the differences?

It is easy to mix up yield and rate of return. They are often used interchangeably. Both terms deal with how much money you make from an investment. So, you would see people casually use them as if they mean the same thing. But there is a difference between return and yield, and you cannot assume them to be the same. 

1. What do both these metrics include?

Let's start with yield. Yield is all about income. It is the interest or dividends you receive from an investment, and is expressed as a percentage. When you buy a bond, for instance, the interest it pays becomes its yield. When you invest in a stock that pays dividends, the dividend payments are part of that yield too. Yield is calculated using the investment's face value and sometimes its current market value. Yield never includes capital appreciation.

Return covers how much an investment has earned or lost in dollar terms from the day you invested to today. Return also includes capital gains along with income. Capital gains refer to the rise in the value of your investment. These gains can be short-term or long-term, depending on how long you hold the asset. For example, if you bought a stock at $100 and it is now at $150, the extra $50 is your capital gain and will contribute to your return, not your yield.

2. How do both metrics help you compare different assets?

You might notice that yield is usually expressed as an annual percentage rate. This makes it easier to compare different investment options. It is usually used for comparing fixed-income products. A higher yield may look attractive, but, as with most things in investing, it usually signals higher risk. The more risk you are willing to take, the higher the income potential tends to be.

Return, on the other hand, calculates how your investment has really performed. It includes the dividends you received, the interest you earned, and any rise or fall in the investment's price. It can be used to compare many types of assets, such as stocks, mutual funds, and real estate. 

3. How are both metrics used?

Yield is simply the income the investment is expected to generate. It is forward-looking. It tells you what you might earn over the term. It also gives you a glimpse of the risk level. When a security is considered riskier, it usually offers a higher yield. A safer product usually sits on the lower end of the yield spectrum because the risk is close to zero.

Return looks back and tells you what happened in the past. When you talk about return, you are talking about the asset’s earnings over a specific period. It includes everything, including any price fluctuations. A return number shows you what you gained or lost, not what you were promised. It has no risk element because the risk is in the past. 

That is a key difference between yield and return. Yield indicates the potential income from an investment, while return shows the investment's actual performance. Yield is forward-looking, and return is backwards-looking. Only when you view them together do you get a clearer picture of what an investment might offer you today and what it has delivered historically.

Difference between yield and return – comparative example   

To make the difference between return and yield clearer, let's take the example of a Certificate of Deposit (CD). 

Suppose you purchase a CD that offers a yield of 1.5%. Since this is a fixed product, your principal will not fluctuate, and you will earn a guaranteed amount as long as you hold it until maturity. In this case, the result is almost too evident. Your yield is 1.5%.

However, your capital appreciation is zero because the CD's value never changes. And that makes your total return 1.5%, same as the yield. 

Making sense of yield and return

You do not have to become an expert, but understanding the difference between yield and return can definitely help you set more realistic expectations. Knowing what each term actually measures can give you a better sense of how your investments earn money. And learning about these concepts can help you understand how your potential earnings are calculated.

Of course, if diving into these details does not appeal to you, that is completely fine too. A financial advisor can take this off your plate. They can track these metrics on your behalf and explain to you how they may affect your investment choices. If you are considering getting professional help, our financial advisor directory can be a helpful place to start your search for someone in your area who understands your needs. 

Frequently Asked Questions (FAQs) about the difference between return and yield

1. What is included in yield?

Yield includes only the income your investment generates, such as interest or dividends. It does not account for any change in the investment's price.

2. What is included in return?

Return includes everything your investment has earned or lost over a period of time. This includes capital gains, interest, dividends, and any change in the investment's market value.

3. Should you calculate both yield and return for an investment?

Yes, calculating both can give you a clearer picture of how the investment works. Yield helps you understand the income potential, while return shows the asset's overall performance. That said, you can also use them individually. Speaking with a financial advisor can help you understand which metrics are helpful for your investment portfolio.

4. What are some other metrics used to measure investment performance?

You can also look at metrics such as beta, alpha, the Sharpe ratio, standard deviation, and others to get a deeper understanding of how your investments have performed. These metrics help you understand the risk involved in an asset and its performance over time.