To understand the importance of yield, we must first understand what it means. Yield is a basic term used to describe the percentage of return an investment will pay.
“Yield is the earnings generated on an investment over a specific time,” says Jim Grant, owner of Grant Investments of Raymond James Ltd., and licensed Portfolio Manager.
Yield can be based on interest earned or dividends received. The amount earned is represented as a percentage based on the invested amount, current market value, or face value of the security. The term can apply to common and preferred stocks, as well as fixed income investments such as government and corporate bonds, notes, and annuities.
A GIC, for example, might yield two per cent, meaning if you invest in the GIC, it will pay you two per cent per year while you hold it; then when it matures, you get your money back.
“For less simple investments (such as dividend-paying stocks), the concept of yield is essentially the same but arguably less straightforward,” says Grant. “There is a subtle difference that can be more than a little confusing.”
Let us start with an example involving a GIC. Let us assume you invest $100 in a GIC offering a two per cent yield. Simple formula: $100 x two per cent means you get two dollars per year in interest.
When you buy a dividend-paying stock, on the other hand, the formula is essentially the same, but there is a difference in how yield is interpreted. In the case of a stock, the yield changes every day as the stock fluctuates in value. If you buy the stock today at $100, and the stock pays a dividend of two dollars, then the yield on the stock today is two per cent. Chances are, the yield will be different tomorrow as the stock price goes up or down. The actual amount of the dividend does not change from day to day, but the current yield does.
So, how important is yield when making investment decisions? With a GIC, the answer is simple: the higher the yield, the better. With a dividend-paying stock, there is a big difference because it is not the actual dividend that fluctuates from day to day: It is the stock’s price. If we assume a constant dividend, the yield goes down when the stock price goes up. Conversely, when the stock price goes down, the yield goes up.
There are a lot of other factors to consider when it comes to dividend-paying stocks, but we can draw a straightforward conclusion from this: unlike GICs, we cannot assume a higher-yielding stock is a better investment. Quite often, the opposite is the case.
At Grant Investments of Raymond James, income investing involving dividend-paying stocks, bonds, and other fixed-income investments is an area of specialty. They work with investors in the Parksville/Qualicum Beach community and beyond to ensure their financial goals are met efficiently and consistently.
“Representing the Raymond James Private Investment Management Group, my team and I offer an excellent wealth management service that can benefit individuals looking for quality retirement planning, estate planning, and wealth management services,” Grant says.
Raymond James Ltd., member – Canadian Investor Protection Fund.