The return is the income generated by an investment over a period of time. It is calculated by taking the interest or profits earned from the investment and dividing it by the value of the investment. It is usually expressed as an annual percentage and excludes capital return, which is the profit made from buying something at one price and selling it at a higher price.
Types of Return
Let’s look at the most common types of returns chosen by investors.
Dividend-Paying Stocks:
Stocks that pay dividends are often aggregated based on the return they generate. We’ll cover the math later, but this is simply the amount of income from dividends you can expect from the stock, expressed as a percentage of the investment value.
Bonds:
Bonds represent one of the more common types of investment that generates a return. The bond yield, which is also represented as a percentage, can be fixed or variable. It operates in the same way as returns on stocks, reflecting the percentage income you can expect on your investment value.
Rental Properties:
Also known as the return on investment rate, the yield from rental properties shows investors the amount of income that will be generated on their holdings after deducting operating expenses.
How to Calculate Return
If you’re not afraid of basic math, it’s relatively easy to determine the return on investment.
Stocks:
When looking up stock prices, you will usually see the annual dividends paid by the company. Divide the annual dividends by the stock price. Convert the result to a percentage and you’ll get the dividend yield on your stock.
Bonds:
Things become more complex with bonds. There are different types of bond yields and various ways to calculate them, depending on factors such as the bond’s duration, coupon, or interest rate, and whether the interest rate is fixed or variable.
Rental Properties:
If you own a rental property, you can calculate the return by taking into account expenses and income. If you bought a rental property for $875,000 and you can rent it out for $2,700 per month with monthly expenses of $975, your yield would be 2.37%. To arrive at this number, determine your monthly net income ($1,725) and your annual net income ($20,700), and divide the annual net income by the purchase price to get the return you can expect from your investment.
Importance of Return in Investment
If you are an income-focused investor, chances are you live off the income generated by your investments, or hope to one day. Within a portfolio focused on income, the return can be as important as capital gains such as rising stock prices.
Return Limitations
Investors face the risk of running into problems related to returns, especially regarding stocks and bonds. You may have heard the phrase “chasing yield,” so let’s look at two key examples of what that means.
Stock Yield
A high yield can lure investors when stocks pay an extremely high return. While a large yield doesn’t exclude investment, it can be a trap as high yields generally indicate a falling stock price.
Bond Yield
Along the same lines, while bond yield may be attractive, investors may avoid relatively conservative bonds in favor of stocks that focus more on capital growth. This example illustrates the old adage that younger, more aggressive investors should focus on stocks with high growth potential, while older investors or those closer to retirement should be in bonds and conservative stocks that generate income.
Conclusions
Main
Yield represents the income you can expect from a particular investment, expressed as a percentage of the investment’s value. It is important not to confuse yield on investment with return. Although they share behaviors and calculations, it is crucial for investors to distinguish between different types of yield. Investors should also be cautious of falling into the trap of high yield. Generally, the lower the value of the investment, the higher the yield. Investors should consider their personal financial situation and their desire to generate income when determining their position in the relationship between capital appreciation and income generation.
Source: https://www.thebalancemoney.com/what-is-yield-5093920
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