Yield or return. Many investors use these two terms interchangeably and ultimately confuse them. However, while both are financial indicators, they are far from describing the same thing.
Yield
Yield refers to the income generated by an asset over a given period. This is why we commonly speak of agricultural yield, real estate yield, and stock market yield. In the latter case, yield corresponds to the annual income provided by a share, specifically the dividend.
To facilitate comparisons, it is customary to relate this income to the value of the asset. This results in a yield rate expressed as a percentage.
More concretely, if a share worth €100 generates a €5 dividend, the share is said to provide a yield of 5%.
Return
The concept of return is broader, as it encompasses all income as well as the costs incurred by the investment.
Let us return to our previous example. If the share is sold for €100 after one year, its rate of return will be 5%, the same as the yield. However, if the share is sold for €110, the return increases to 15%.
The calculation here involves the concept of the internal rate of return (IRR), which measures the annual rate of an investment producing the same cash flows. It is naturally more complex to intuitively determine the IRR level of an investment over several years, but a simple spreadsheet allows it to be done easily. One simply needs to list the inflows and outflows year after year (or over the chosen periods).
The rate of return therefore measures true performance over time, including all parameters. It allows one to verify, for example, that an equity investment can have zero or negative return despite a high yield: if the loss upon resale (or the fees) absorbs all the dividends.
The Weight of Duration and Final Value
The rate of return also allows for measuring the importance of the time value and the final value (resale price).
We previously mentioned an investment of €100 in a share providing a €5 dividend each year. Assuming a resale at the same price, this share will offer a yield and a return of 5%, regardless of the duration of the investment.
In the event of a resale with a 20% capital gain (€120) after five years, the average annual rate of return will instead climb to 8.38%. This figure shows the importance of an asset's resale price on the average annual return of an investment: at least over short periods.
If this same capital gain is achieved after 10 years, the gain in return is indeed more modest, with the average annual performance limited to 6.48%.
Finally, the observation is even more striking over a 20 year period, as the average annual return then does not exceed 5.57%.
In summary, it appears that the sale price determines a large part of the return on a short term investment. Conversely, its influence proves to be more limited as the investment period lengthens, with the regular yield then constituting the bulk of the performance.
Average annual performance of a €100 investment in a share paying a €5 dividend
