Investment yield is the amount of income expressed as a percentage that you earn on your portfolio in a year. Like a savings or checking account at your bank, or a money market fund, your portfolio will have an equivalent to an ‘interest rate’ expressed as a percentage.
There shouldn’t be much work to figure this out, your broker should calculate it for you when they send you a monthly statement. However, there are different ways of looking at this and there isn’t just one way to calculate it. As we will see, the yield that your broker provides may understate how well your investment is actually doing.
In this article I will discuss (4) main ways of calculating investment yield and what each one tells you.
Why Portfolio Investment Yield Is Important
Here at JavaInvestor, we are more focused on investment yield than portfolio value. There are a number of reasons for this. First, how much you earn on your portfolio and how much it grows over time is more important than what the market value of those investments are. This is somewhat contrary to popular punditry out there, but this is a strategy that can really work for you over time. When your earnings and income in your portfolio increase, the market value of those investments will go up but it isn’t always that case that these two events will coincide. The market can either over price and under price an investment at any given time.
During the Great Recession of 2008, my investment portfolio remained intact because the companies that I owned kept increasing their dividends. This is a more powerful statement about the health of those businesses than what the market valued them at during any given day.
An Example Portfolio
I will use the following portfolio to demonstrate the calculations. To keep it simple, assume that you bought the stocks at the beginning of the year and then totaled up everything at the end of the year. There was an increase of 8% in the value of each position at the end of the year.
Initial Investment: $10,000
Money Added During Year: $2,000
Investment Yield @ Purchase: 5%
Dividend Increase During Year: 10%
Year End Portfolio Value: $13,608
1) What Your Broker Will Report
The broker will report on your statement the current investment yield as of the statement date. In this case, the investment increased in value of 8% after the investment initially had a 5% yield when it was purchased. This yield is called investment yield on value (IYV), because it uses the current value of the investment in the calculation.
The 8% increase in the investment value reduces the IYV to 4.62%. This would be the same investment yield that Yahoo! Finance, Google Finance, or Wikinvest would report.
2) Investment Yield On Cost (IYC)
The value of the investment changed but the yield on your initial purchase doesn’t change. From this point of view, no matter what the price change of the investment, you will still earn 5% going forward assuming other things constant. The IYV calculated above only comes into play when you are reinvesting money or adding money to the portfolio.
IYC will always go up when the dividends are increased because it does not take into account any price change, only your initial price that you paid. So, the initial IYC is 5.0%. Since the dividend was increased by 10% during the year, the IYC increases to 5.5% by the end of the year.
3) Compound Investment Yield On Cost (CIYC)
The total amount you invested for the year was $12,000 ($10,000 initial investment plus another $2,000 along the way). However, you have more than $12,000 working for you because you reinvested the $600 in dividends you collected along the way. Also, the investment increased its dividend rate by 10% (to 5.5%).
From this point of view the CIYC is 5.8%, when you add it all up.
4) Forward Investment Yield On Value
Eventually, your broker will catch up and apply the new investment yield that will apply to future income earned. When they do, they will again calculate it based upon the current market value of the investment. In the example above, an increase in the dividend by 10%, coupled with the 8% share price appreciation comes up with a FIYV of 5.08%.
So there you have it, 4 different ways of calculating the investment yield for the same investment during one year.
IYC: 5.00% (Initial)
IYC: 5.50% (End of Year)
As you can see, what you broker reports can understate how your investment is really performing. Over time, you want to make sure that CIYC is increasing because that is the one that determines if you are making more money.