Choosing investments-why you need to understand yield

Thinking about investing some hard-earned cash in property or shares? You need to have a basic understanding of yield, in that case.

Yield is a future looking measure of the income you can expect from a given investment. Yield is expressed as an annual percentage based on the initial investment.

Buy to let investment

For example, let’s take a look at a buy to let property investment. Assume you buy a property in County Meath for €250,000.

Let’s say you do your research in the particular area where you intend purchasing and you can anticipate a rental income of €1,200 per month. This amounts to €14,400 per annum gross income.

This gives you a gross yield of €14,400/€250,000 giving you 5.76% per annum.

Yield allows you to compare investments in different assets and asset classes for you can easily compare the return in different geographical areas in the same asset class and compare with other asset classes-for example, shares.

With shares you will be able to ascertain the historical dividend yield which a company has usually paid out and you will be able to get a good handle on what the anticipated dividend will be in the future. This will allow you to compare the yields between property and shares, for example.

This is yield at its most basic. You will need to consider other factors, however.

Your gross yield with our hypothetical property may be 5.76% but this is a gross figure.

You will need to consider annual costs of your investment property. These costs will almost certainly include interest on the money you have borrowed, annual maintenance costs, and management company fees if you have purchased an apartment in a multi-unit development.

You will not have these costs when you invest in shares but you will not have the ability to leverage your asset either.

You will also need to consider the taxation situation with both asset classes as you will have to account for your rental income, dividend income, and capital gains on any disposal of assets.

Earnings yield from companies

You need to distinguish between dividend yield and earnings yield of a company in which you might invest.

Dividends are cash in your bank account, assuming the company continues to pay out dividends.

Lloyds Banking Group PLC, for example, has a dividend yield of 4.67% as I write this.

A company could be showing strong earnings yield but not be paying out cash in dividends. Earnings yield is calculated by dividing the earnings per share by the share price.

If the price of the shares increase over time an investor’s overall return would be increased.

But he should be able to rely on the dividend flow to his bank account, regardless of the value the stock marked puts on the share. This may be extremely important to the investor depending on what stage of his life he is in.

Obviously, an older retired person will be concerned with a steady, predictable flow of dividends. A younger person may be more interested in taking a risk, capital growth and gains, and so on.

Yield v risk

No discussion of yield can ignore risk. You may wonder why anyone would accept a yield of 3% if you can get a higher yield. But that higher yield will almost certainly mean a riskier investment.

You are always making a trade off between risk and yield in assessing any investment. And a retired person will be risk averse whilst a young professional or entrepreneur may be willing to take on plenty of risk.

A younger person can recover, remember, if things go wrong whereas an older investor may not have that luxury.