Average Annual Yield

  

Categories: Investing, Metrics

Some investments make money when they rise in value. Most stocks work this way (buy low, sell high). The amount of money you make on these is known as the return. Other investments make money by paying off a set amount of cash. Most bonds work this way...you loan money out and receive regular payments of interest and principal. These types of returns are known as the yield.

The average annual yield is a pretty straightforward way to figure out how much one of these yield-generating investments is paying off over time. Just look at the performance over a number of years and average out the per-year yield during that time. That's it. It's like Average Annual Return (AAR), except with yield-generating investments. These include things like bonds and dividends.

Related or Semi-related Video

Finance: What is Yield to Maturity?6 Views

00:00

finance a la shmoop what is yield to maturity yield it's the dough you get

00:09

back from your investment in a bond here's a thousand-dollar bond here's the [pigeons sitting on a line]

00:13

coupon of 7% so the yield is 7% while the bond lasts for 10 years and then

00:19

after paying you 70 bucks a year for a fat and happy decade of sitting on your

00:23

Duff collecting your interest you get your grand back and well that's it right [check changes hands]

00:27

um no well what happens if you bought that bond for nine hundred bucks or

00:32

twelve hundred bucks or some other random amount yeah way more complex well

00:36

there are two ways you make money from investing in a bond first there's the

00:40

interest as we just outlined 70 bucks a year the semi annual festival of dances [people dancing together]

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when the interest payment is made right it's 35 bucks twice a year easy but then

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there's the appreciation of the principle of the bond and yeah it could [flying crow starts inflating]

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be depreciation of it - all right you bought a 6% yielding bond at a discount

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to its thousand-dollar par value like say you paid 92 cents on the dollar nine

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hundred twenty bucks for a thousand dollar par value bond well over ten

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years you hold that bond until it matures it will appreciate in value I

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call it - eight bucks a year and then it will pay to investors that thousand [check change hands]

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dollar par value well yield to maturity which doesn't apply to shmoop writers

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takes into account both sets of cash flows into your wallet the interest

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yield plus the appreciation of the principle of the bond so in this case

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the bond was paying interest of 60 bucks a year but then it also had appreciation

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of eight bucks a year for a total of 6.8%

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or 68 bucks a year in appreciation all right is this all there is to it you

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just throw in a straight line number therefore the annual appreciation eight

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bucks every year smoothly that's of the principle until it hits par and then

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you're done no not at all life is never that simple all kinds of curveballs will

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be thrown at you all over your head there and you think about you to [flying bird dodging balls]

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maturity okay here's one for starters what about the time value of money

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remember that thing ie the cash that you get twice a year in bond interest well

02:09

couldn't you reinvest that money elsewhere like it

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moment the moment you collected 10 years earlier before bond matures and make

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more money well sure you could and what about the application of straight-line

02:19

depreciation to the gain of 80 bucks over 10 years like why does the bond

02:23

depreciate exactly eight dollars a year in value instead of Raoh maybe less in

02:29

the early years and more in the later or or vice versa

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yeah lots of curveballs and some of these are just accounting decisions or [businessman studying papers]

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the way things are done and the way things are done in bond land is usually

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driven largely by the way the IRS wants to tax you got it so that whole [Uncle Sam walking down the street]

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straight-line depreciation thing and that's largely an IRS driver and here's

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another some bonds are callable early so what if this bond was callable after

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five years but at 102 or a $20.00 premium per bond or a thousand twenty

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well then yeah the yield calculation is different and it's normally called out

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as a quote yield to worst unquote or rather yield to the worst possible

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outcome of the bond other than it going bankrupt or you know not paying on time [coins dropping]

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in this case the yield to worst would be an appreciation from nine twenty two a

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thousand twenty or a gain of a hundred bucks then over just five years so you'd

03:21

add twenty bucks a year to the dividends of sixty bucks a year and you'd get a

03:25

well at least a notional yield here then of eight percent right if the bonds were

03:29

in fact called at ten twenty thousand twenty bucks each got at eight percent

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or does that yield to worst is that the worst you knuth know it's not the worst

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at all the normal trajectory of this bond has it maturing in a decade and at

03:41

par not at a premium to par that ten twenty thing so it isn't bad to be a

03:45

yield to Wurster in this case it's just that if the bond is called early well [crow flying]

03:49

that would be the worst it would do other than like you know not pay off or

03:53

go bust and obviously this is all about appreciation when you buy it

03:57

depreciation you know works the same so just relist into this video in Reverse

04:02

and sometimes worst ain't so bad you [two birds on a line]

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