Have you ever opened your Schwab
brokerage statement or Foster & Motley appraisal and thought to
yourself…this is like reading Greek? You
are not alone. The financial services industry, like a lot of industries, has
its own set of terminology. While our
intent is to provide a thorough report of your portfolio’s activity and
performance, we realize that sometimes industry terms can be bewildering.
Two terms that often lead to
misunderstanding are yield and total return.
Yield (sometimes called “current yield”) measures the income that an
investment generates or earns. Income
generated from bonds is called interest, and income generated from stocks and
mutual funds is called dividends. Yields
are often expressed as a percentage of an investment’s current value. For example, the current yield of XYZ stock
trading at $33.50 per share and paying an annual dividend of $1.00, is 3%
($1.00 divided by $33.50). Yields are
also generally expressed on an annualized or forward-looking basis, meaning
that income received over some length of time is converted to a rate that is expected
to be received yearly. An annualized
rate is just an estimate and not a guarantee. For example, on January 31, 2014
XYZ company paid a quarterly dividend of $0.20 per share. If the company pays that same amount for the
next four quarters the total amount of the annual dividends per share would be
$0.80 or an annualized yield of 2.4% (assuming the same stock price of
$33.50). However, let’s say that the
company raises its quarterly dividend to $0.25 per share in April; the
annualized yield would increase to 3.0% based on the new annual dividend of
$1.00 ($0.25 x 4).
Why is yield important? First, a company’s ability to pay its
investors a steady stream of cash over time is a good indicator of that
company’s financial strength and long-term viability. Second, a steady stream of cash flow provides
a stable contribution to a portfolio’s total return, which is especially
important during downturns in the market.
Total return, on the other hand, not
only includes the income of an investment but also its appreciation (capital
gain) or depreciation (capital loss) in value.
A capital gain or loss occurs when a security’s price increases or
decreases in value. Unlike the yield of
a portfolio, total return is backward looking, meaning that it measures the
performance of an investment over some previous time period. There are various methods of calculating
performance, but we use time-weighted
rate of return. The total account
performance presented in client appraisals is calculated net of all commissions
and trading costs. We also present
performance gross and net of our fees on the Account Summary report page and
gross of fees on the Portfolio and Asset Class Performance History report as
recommended by the CFA Institute.
Yield and total return are just two of the measures to examine when assessing whether a portfolio is achieving your financial goals. Please feel free to ask us about these terms at your next meeting.