Investment Yield – A Valuable Metric for Investors

Investors should be familiar with many terms, concepts, and formulas to find fitting investment solutions. Using yield to determine an investment's profitability is a good starting point to dive deeper into analyzing and assessing investment options. The basic formula to calculate the yield percentage value is easy to use but has to be adapted to fit certain investment types. As soon as you have determined various vehicles' profitability, make sure to start investing in CARL's sophisticated quant hedge fund strategies to diversify your portfolio.

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What Is Yield?

Yield is a measurement to describe how profitable an investment is. The formula examines an arbitrary time period – usually a period of one year. The formula to calculate the current yield of an investment gives you a percentage. And the higher this percentage is, the higher the yield of your chosen investment.

By its nature, the theory of yield assumes that the growth or trend it describes will remain constant. If you invest in an asset because of its current yield, you expect the investment to yield as much in the near future as it has in the time frame that was used to calculate the yield percentage.

Using yield to choose which assets to invest in narrows your options as it can only be used to assess investments that produce an interest rate or pay dividends.

One factor which is essential to any investment decision is risk. This is also true if you seek to invest based on yield percentages. Investors typically associate higher-risk investments with a higher yield potential. Generally, hedge funds are riskier than mutual funds or ETFs. But they also offer a higher yield potential, which in turn can grow your principal investment in a shorter time frame. This allows you to invest in more assets to further grow your wealth.

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Yield vs. Return: Similar, but Different?

Total return is another key metric that investors consider when evaluating investments.

Calculating the total return takes into account interest rate, dividends, capital gains as well as distributions. Instead of an annual assessment, total return is calculated for an arbitrary period of time.

Total return calculations also include appreciation and income. Investors using this metric as their primary guide for decision-making usually focus on two things: growing and diversifying their portfolio. The main objective is never just preserving the initial investment but growing reliably and safely as these investors don't want to see their portfolios diminishing in value. But that much is true for any investor.

Total return only reflects on positive outcomes of the calculation, though. An asset or an investment can always fall through, so returns always consider both wins and losses, while total return doesn't. With this in mind, return is the more decisive metric as it describes both possible outcomes. You also have to keep in mind that return is a retrospective metric. This metric looks only at the past performance of a metric, and it doesn't claim to describe possible future gains.

This retrospective nature of returns as a metric is one of the biggest differences between return and yield. The latter is forward-looking because investors expect the calculated yield number to at least stay on its current level – or, better yet, continue to grow.

Applicability is another critical difference for the two metrics. The return rate is a reliable tool to assess various assets and asset classes to invest in. Yield can only be calculated for investments that follow interest rates or generate dividends.

Why Yield Is Important

From an investor's perspective, yield can be a key metric in two scenarios. The first is when you're in the earliest investment stage when you decide which assets to put money into, especially if the goal is short- or medium-term gains. If you're looking to increase your cash flow quickly, high-yield investments are the way to go. High-yield investment options are more likely to create quick gains on initial investments.

Yield and higher-yielding investments are a hot topic for discussion between dividend investors and value investors. The long-term approach for growth with safe investments that value investors rely on runs contrary to high-yield, shorter-term gains which dividend-oriented investors strive for.

The other scenario in which yield is a key metric to look at is in anemic or slow-growing market circumstances – a situation which happens mostly during recessions or when economies slow down – these are financially unstable and uncertain circumstances. General money market or stock market instability leads investors to turn to yield as a metric for choosing investments. This works as a hedging strategy protecting investors and their investments from high market volatility and increased risk.

Volatility and risk are also reasons to consider yield a key metric when investing in a sector or industry. As soon as these grow, despite a volatile economic climate, investors who have decided to invest in them due to yield-driven decision-making may benefit from increasing, dividend-paying gains.

If you want to use yield as a defining base metric for investment decisions, it should fit your investment strategy. If you're looking to increase your income in a shorter time period at a medium level of risk, it's perfectly fine to use yield. On the other hand, investors who seek long-term gains and don't shy away from holding onto assets in the long term (and usually seek to diversify their portfolio with various asset classes such as real estate, dividend stocks, or ETFs) are better off calculating with other metrics and baselines.

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How to Calculate Yield

There is a simple formula that you can use to calculate cash flow based on your initial investment amount. The time frame you choose to calculate the yield usually consists of a business year, but other variations are possible – for example, calculating quarterly or even every month.

The basic formula for yield is: Net realized return ($) / Principal investment ($) = Yield (%)

Let's look at an example to break the formula down even more: You have used a robot advisor to purchase shares on the stock market. You initially bought ten shares at a stock price of $100 each. After a year, you sell your shares for $1200. Additionally, you receive an annual dividend of $1 per share, which comes to $10 in total dividends. To get the net realized return, you have to add your total dividends to the selling price of all 10 shares. This sum is then divided by the initial share price. Applying the formula, we arrive at a total yield of: ($200 + $10) / $1000 = 0.21 or 21 %.

Things to Keep In Mind

Since high-yielding investments generate higher amounts of cash flow and income, a high value is often seen to indicate a low-risk investment. But you have to keep in mind the underlying yield calculation. The impressive value may have resulted from a drop in market value, which should be a point of concern for investors.

Also, a high yield percentage can result from a large dividend income or decreasing stock prices. Increasing dividends, in turn, have to be taken with a grain of salt as they could result in rising stock prices. This is because they are based on the earnings a company has made.

The combination of high stock prices and high dividends usually leads to only marginal but consistent rises in yield. If yield grows significantly despite these circumstances, this can indicate short-term cash flow problems for the asset, which could be detrimental for investors.

Different Types of Yield

There are three defining factors for different yield types:

  • Investment duration
  • Return amount
  • Type of asset

There are two important metrics for stock-based investments: YOC – yield on cost – and current yield. Cost yield is calculated with the original purchase price. However, current yield uses the current market price instead of the purchase price. Rising stock prices lead to a decreasing current yield.

Bond yields

If you invest in bonds that pay returns annually – no matter if they are corporate bonds, government bonds, or municipal bonds – you can determine nominal yield with the following formula: Annually earned interest divided by the bond's face value equals the nominal yield. But this doesn't apply to bonds with a floating interest rate.

Three Special Types: YTM, YTW, and YTC

YTM or "yield to maturity" is a specific measuring tool for bonds held until their maturity date. The value is seldom subject to change and is expected to stay stable and consistent until the bond reaches its maturity.

Yield to worst describes the lowest possible yield potential without it defaulting. It works on a worst-case basis and is used for risk measurement to secure the investor's minimum income requirements even in the most dire of circumstances.

Callable bonds – special bond funds – are redeemable before reaching their fixed maturity date. YTC or "yield to call" refers to the bond's yield value at the specific time when it's called. To determine this yield value, you must include market price, interest rate payments, and the duration until the call date because the interest amount is defined by that period.

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Investing for Yield – Is It a Good Idea?

Short answer: It depends. If you’re using yield as a base metric for your investment decisions and to build your portfolio, then it has to fit in with your general investment strategy. If you're looking for long-term growth with high annual dividends, stable income, and a portfolio diversified to a certain degree - other metrics and values are more useful. But for other strategies and agendas, it is a suitable guiding metric.

If you know your way around the world of finance, high-yielding quant hedge fund strategies with low minimums and 15%+ targeted returns are a great way to diversify, no matter what metric you use. Invest in CARL's sophisticated strategies to grow your wealth and set yourself up for a prosperous financial future.

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