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What Is Yield? Why Is It Important in Finance?

Yield is an attractive feature in any asset class. Many investors pay careful attention to an asset's yield percentage when choosing which products to add to their portfolios. While yield is never guaranteed, it provides investors with a measure of certainty they will generate passive income on their holdings. 

So what is yield, and why is it such an attractive feature? Also, how can investors calculate yield cash flow into their yearly earnings?

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What is yield?

In finance, yield refers to the income an investor receives for holding specific assets. Since all investors need to keep the asset in their account to generate yield, yield is considered a form of "passive income." 

Although there are many types of yield for various asset classes, yield is always expressed as a percentage on top of the held asset. Most often, this percentage denotes how much you’ll earn on an annual basis. 

Remember that yield is distinct from any profit a trader would realize for selling an asset at a higher price. There’s no need to buy and sell a security to "realize yield." Instead, you can earn yield for as long as you keep your yield-bearing assets. 

How to calculate yield

The standard way to calculate yield is to divide your expected yield in USD by the principal you spent on an asset. After you get this result, you need to multiply by 100 to get a percentage. This yield formula is sometimes called the "cost yield" since you're figuring out the yield on the average "cost" you paid for your asset. 

As an example, let's say a stock offers an annual dividend of $1 per share. Buying one share of this company for $100 would mean an annual yield of $1 on this investment. In percentage terms, you’d get a 1% yield on every share you purchase, i.e.:

($1/$100) x 100 = 1% 

To figure out how much you'll make in dividends, you can multiply this percentage by the total dollar value of your holdings. So buying 50 shares of the company for $100 per share would equate to a market value of $5,000. Then, if you multiply $5,000 by the interest rate of 1%, you can expect to receive $50 in interest. 

However, remember that this yield percentage will change as the share price increases or decreases. To determine the "current yield" on an asset, you have to put the current market value of your security in the denominator spot. 

Continuing the example listed above, let's say the market price of the stock went up to $110. So, if the company didn't issue a dividend increase, the current yield would now be 0.9%, i.e.:

($1/$110) x 100 = 0.9% 

Types of yield

There are many assets in traditional markets that offer a yield. However, the three most common yield-bearing assets are dividend stocks, bonds, and real estate. Let’s go through each in detail. 

What is dividend yield?

If you want to know what yield is in stocks, you first need to learn about dividends. A dividend refers to a portion of a company's profits distributed to shareholders. Businesses that offer dividends will often issue them to stock investors once per quarter. 

Companies will often post their dividend as "dollars per share." For example, Apple offers a dividend of $0.92 per share (at the time of writing), which means you would earn 92 cents for every Apple share in your portfolio. 

To figure out the annual percentage yield on a dividend, you’d need to divide the dividend per share by the security's current price. Next, multiply this number by 100 to get the current dividend percentage. 

For example, if one Apple share is worth $146, you’d use the following formula:

($0.92/$146) x 100 = 0.63%

As a stock's price falls, its yield will increase. Although this high yield may look more attractive, it doesn’t account for the loss in your initial principal. 

Consider looking at the "ex-date" when evaluating when to buy a dividend stock. The ex-date is the last day you can purchase a security and receive the upcoming quarterly dividend. If you buy this stock after the ex-date, you'll have to wait until the next quarter to receive dividend payments. 

What is bond interest yield?

A bond is a debt issued by a corporation or government. When you invest in bonds, you loan money to the issuer. As you wait for your investment to mature, you, the bond investor, will receive the interest in the form of "coupon payments."

To determine the coupon rate of your bond, divide the annual dollar amount you'll receive by the principal you spend on the bond. Lastly, multiply by 100 to get the yield percentage. 

For example, if the bond’s price is $100 and it pays $6 per year, you’d divide $6 by $100 to get a yield of 6%, i.e.:

($6/$100) * 100 = 6% 

What is yield in the real estate market? 

If you’re involved or invested in the real estate market, you can earn a yield on your properties by renting them out. While renting apartments can create a steady passive income stream, you should remember to subtract all your monthly expenses (e.g., property taxes and energy) from your rent payments when calculating the annual yield. 

For example, if you're renting a house for $1,500 per month and expect to pay $900 each month, you’d generate about $600 per month. 

To express this rate as a percentage, multiply it by 12 months and divide it by your principal investment. Let's assume you spent $100,000 for the property you're renting. If so, you'd end up with the following formula: 

[($600 x 12)/$100,000] x 100 = 7.2% 

What's the difference between yield and return?

Interest is only a part of the total return on an investment. While "return" includes all the interest you've collected, it also calculates the total amount you gained after selling your assets. To figure out the total return, you must know how much you initially paid for your security, how much of a profit you made after selling it, and the interest you accrued while holding it. 

Let’s look at an example. Suppose you bought one Apple share for $146 and sold it at $156. The return on your investment thus far is $10. If you held your stock for a year, you’d also have a dividend payment of $0.96. So your total return on investment (ROI) from one Apple share would be $10.96.

You can express this return as a percentage by adding the interest and profit from your Apple share and dividing by the price you paid for the stock. You’d then multiply by 100 to get a percentage, i.e.:

($10.96/$146) x 100 = 7.5%

How does yield work in crypto?

There are as many opportunities to earn yield with cryptocurrencies as with traditional asset classes. In fact, since crypto is a part of the new field of DeFi (decentralized finance), there may be more options for crypto investors to generate passive income. 

However, since cryptocurrencies are new, they’re more volatile than assets like dividend stocks or bonds. Also, cryptocurrencies don't have the same federal insurance protections that established yield-bearing assets enjoy. While there are many ways to earn yield with crypto, they come with a higher degree of volatility and risk.

Here are a few ways you can earn a yield on cryptocurrency: 

  • Yield farming: DeFi users can lend their crypto to liquidity pools in many dApps (decentralized apps). These liquidity pools run on smart contracts and allow users to exchange tokens without the need for a central authority. In exchange for supplying tokens to a DeFi protocol, "yield farmers" earn a percentage of trading fees or interest payments. 
  • Staking tokens: Blockchains that use the proof-of-stake (PoS) algorithm need users to lock their crypto on the blockchain to secure the network. If you meet a blockchain's minimum requirement for a "stake," you’ll have the chance to validate transactions and earn token rewards. But, if you don't meet the minimum staking requirement, you can "delegate" some of your tokens to a staking pool to earn a percentage of these rewards. A few notable PoS blockchains include Ethereum, Solana, and Polkadot. 
  • Crypto lending services: There are many centralized and decentralized crypto lenders. If you deposit crypto into a lending platform, you’ll receive a percentage of the interest payments from the platform's borrowers. 
  • Metaverse land rentals: Renting land in the metaverse remains a "niche" field, but it’s a viable way to earn yield in the crypto economy. Platforms like Decentraland and The Sandbox allow investors who own NFTs (non-fungible tokens) that represent virtual land to rent them to other players. 

Wrapping up

Yield is a significant consideration when deciding what to invest in. While not all assets offer yield, those that do can provide steady passive income for long-term holders. Calculating the average yield on your holdings can help you better plan your financial future. 

At Worldcoin, we’re excited about the many yield opportunities opening up in Web3. However, new crypto investors should know the risks associated with investing in DeFi. For more information on securing your crypto, subscribe to our blog.  

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