When you become an investor, you buy into an investment vehicle. The money you choose to invest becomes your principle and whatever value that investment grows into becomes your return. But return is what you get after you’ve already made an investment. To understand how good (or bad) a potential investment is, you need to look at yield. 

Investment yield is the percentage of return on capital represented by the investment income, expressed as a percentage of the price. The higher the yield, the better the investment’s performance will be over the holding period. It’s a tool many investors use when buying bonds or calculating the potential income of a dividend-paying security.

Yield is actually an umbrella term. Different types of investments measure yield using different variables. The purpose of determining yield is to get a sense of how your money will work for you over the life of an investment. 

The Formulas for Investment Yield

There’s a way to measure yield for virtually every type of income investment product. If it offers a dividend, interest payment or other form of income, it’s possible to calculate the expected yield. 

Calculating yield depends on what investment vehicle you’re looking at. While there’s a generalized formula for yield, stocks, bonds and other investments have unique variables that affect their profitability. Here’s a look at some of the basic yield formulas for investments and how they differ slightly:

• General: Yield = Net Realized Return / Principal Amount
• Stocks: Yield = (Price Increase + Dividends Paid) / Purchase Price
• Bonds: Yield = Annual Interest Earned / Face Value of Bond

Investors can plug real variables from assets into these formulas to get a generalized idea of what they can expect that asset’s yield to be over the holding period. Using these formulas, investors can and should compare like-kind investments to get a better look at the potential of each by comparison. 

Different Measures of Investment Yield

Yield is most-often associated with bonds and debt instruments. The coupon rates, par values and maturities of these products give investors many different ways to measure yield. Some of the most common include:

• Yield to Maturity (YTM). Average annual expected return on a bond held to maturity. 
• Yield to Worst (YTW). Lowest potential return available on a bond at risk of default.
• Yield to Call (YTC). The measure of the bond’s yield at the time of its call date.
• Tax-Equivalent Yield (TEY). The pretax yield of a bond needs to equal a tax-free bond.
• Mutual Fund Yield. Represents the annual net income return of a mutual fund.

Examining yield through different lenses can tell investors a lot about what they can expect from that asset. Moreover, the various types of products demand a closer look at yield based on how they behave. For example, if you hold a callable bond, YTM might not show as clear a picture of yield as YTC. Likewise, if you’re interested in a junk bond gamble, knowing YTW vs. YTM can give a clearer look at a more realistic scenario. 

What Can Investors Learn From Yield?

Yield is a look at potential profitability. Investors need to use it as a forward-looking tool when trying to set expectations for an investment or when choosing between two like-kind investments. Knowing how to calculate yield brings context to investments in a way that makes it easier to plan a long-term investment strategy. Whether it’s a bond, dividend stock or an annuity, calculating yield gives investors confidence to put their money to work in the best way.   

While it ignores capital gains, yield gives investors a clearer look at the fundamental nature of an investment from a more intrinsic standpoint. In that way, it leaves less up to market sentiment and lays bare the inherent potential of the investment to generate wealth over a period of time. 

Yield vs. Return: What’s the Difference?

In simplest terms, yield is forward-looking; return is backward-looking. Investors calculate yield to see future income based on current variables. Meanwhile, return looks at the income already earned. 

• Investors often examine yield on dividend-paying stocks, corporate bonds and fixed-income securities. For example, an investor might weigh the YTM of a 10-year corporate bond vs. a dividend-paying stock’s yield over a five-year period to determine which is the more worthwhile investment. The ability to look ahead informs their choice.
• Return is useful for evaluating performance of investments you already own. An investor might look at the returns from two stocks in their portfolio when deciding where to take profits—or where to prune for rebalancing.

Yield and return are two measures of investment profitability, both important considerations at different stages of the investment life cycle. 

Pay Attention to Yield When Investing

Income investors need to pay close attention to yield when investing. The ability to look ahead at the expected yield of an investment plays a big part in the decision of where to put your money. At the same time, realize that yield isn’t always a guarantee—especially in the face of changing variables like appreciation, interest rate, fees, etc. It’s meant to serve as a measure of risk and to help inform investor expectations. 

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Pay close attention to yields in context, too. While high investment yield tends to signal higher income, it could be the result of something like a falling stock price. Examine yield in the context of the investment, and make sure it tells a story of strong future returns.