Yield or return. Many investors use these two terms interchangeably and ultimately confuse them. However, while both are financial indicators, they are far from representing the same thing.

Yield

Yield refers to the income generated by an asset over a given period. This is why we commonly speak of agricultural yield, real estate yield... and stockmarket yield. In the latter case, the yield represents the annual income provided by a share, i.e. the dividend.

To facilitate comparisons, it is customary to relate this income to the value of the asset. This gives a yield rate expressed as a percentage.

More concretely, if a share worth €100 generates €5 in dividends, it can be said that the share provides a yield of 5%.

Return

The concept of return is broader as it encompasses all income, as well as the costs incurred by the investment.

Let us return to our previous example. If the share is sold for €100 after one year, its rate of return will be 5%, the same as the yield. However, if the share is sold for €110, its return rises to 15%.

The calculation here involves the concept of Internal Rate of Return (IRR), which measures the annual rate of an investment producing the same cash flows. It is naturally more complex to intuitively determine the IRR level of an investment over several years, but a simple spreadsheet allows it to be done easily. One simply needs to list the inflows and outflows year after year (or over the chosen periods).

The rate of return therefore measures true performance over time, with all parameters included. For example, it allows one to verify that an investment in shares can have a zero or negative return despite a high yield... if the loss upon resale (or fees) absorbs all the dividends.

The weight of duration and terminal value

The rate of return also allows for measuring the importance of the time value and the terminal value (resale price).

Above, we mentioned that an investment of €100 in a share providing €5 in dividends each year. Assuming a resale at the same price, this share will offer a yield and a return of 5%, regardless of the duration of the investment.

In the event of a resale with a 20% capital gain (€120) after five years, the average annual rate of return will instead climb to 8.38%. This figure shows the importance of an asset's resale price on the average annual return of an investment... at least over short periods.

If this same capital gain is obtained after 10 years, the gain in return is indeed more modest, with the average annual performance limited to 6.48%.

Finally, the observation is even more striking over 20 years, as the average annual return then does not exceed 5.57%.

In summary, it appears that the selling price determines a large part of the return on a short-term investment. Conversely, its influence proves to be more limited as the investment horizon lengthens, with regular yield then constituting the bulk of the performance.