What You Need To Know About Investment Yield
Yield. There are few more important concepts in investing. Because telling someone you made $1,000 on an investment is not a complete statement. If you invested $1,000 and now have $2,000, you have earned a hefty gain (or yield) as a percentage of what you invested. If on the other hand, you invested $1,000,000 to earn that $1,000, it’s a different story. Frankly, until recently that was about the annual yield one could expect from money market funds and T-Bills. But I digress.
This article is about the trends I notice in two of the most critical “yields” in investing today. After all, yield can be applied to many different aspects of investing (or farming, for that matter). In my daily investment practice, THE most important yield is that derived from dividends paid by the stocks and ETFs I own (dividend yield). For bond investors, the yield is provided by the interest they earn on their bonds, as a percentage of what they invested (cost yield), as a percentage of the current value of the bonds (current yield), or a more complex calculation of what their return on the bond will be if they hold it until it matures in the future (yield to maturity).
The biggest mistake I see investors make regarding the discussion of yield is to confuse the yield they earn from stocks. The cash they are paid by the company while they own the stock is “dividend yield,” and when and how much they are paid is no mystery: the company announces the amount and date weeks or months before it is paid, as well as the date upon which one must own the stock to qualify to receive the dividend. That part is pretty straightforward, but I constantly hear investors refer to how much “yield” they are getting when in fact that are talking about their “total return” – how much they have gained from their investment – without distinguishing between the PREDICTABLE cash flow from the dividend, and the change in the price of the security they own. That may not seem like much in a feverish bull market, but when the price gains fade, the dividend portion of the yield (assuming you are in solid companies that continue to pay a dividend) is still there.
In particular, the retired or pre-retired investor has to be conscious of this. Otherwise, they risk getting emotional when those price gains reverse. Frankly, this is what I think retirement investing is all about in the coming 5-10 years at least: deciding how you want to pay yourself in retirement. How much of your “earnings” in retirement will come from predictable sources (dividends) and how much will come from the less-predictable and currently vulnerable price gains. The good news is that you have a choice. The bad news is that many, many investors will err on the side of greed, and minimize the importance of dividend yield in favor of price appreciation.
And for bond investors, it will be much worse. After all, yields on bonds are pretty low to begin with. But more importantly, bond prices are as likely to go DOWN and not up as they have been in about 40 years. That has the potential to surprise/shock/disappoint investors, and cause retirement plans to spin out of control with emotional decisions.
THE CURRENT MARKET FOR YIELD (IN PICTURES)
I wanted you to have that background on the topic of yield before showing you the charts below. You see the historical path of both the “earnings yield” and dividend yield of the S&P 500. I reviewed dividend yield above, so let me also explain that earnings yield is simply the earnings of the collective stocks in the S&P 500 Index divided by the S&P 500’s price. It is essentially how much earnings are being produced by an investment in the S&P 500. Unlike dividend yield, that is not cash in your pocket. But it is a decent and popular valuation measure used by Wall Street analysts to assess the value of the broad stock market.
What I see in these charts is the following:
- The S&P 500 earnings yield has been falling for a while now
- Past declines that look like this one have preceded recessions and major drops in the S&P’s price
- The S&P dividend yield has also been falling. But I would quickly point out that this has more to do with the increasing dominance within that index of stocks that pay little or no yield (FAANG, etc.)
The one thing I DO know is that there are plenty of dividend yield opportunities out there for investors, retired or otherwise. But as with nearly every indicator I view and show to you these days, the message is the same: the major stock market indexes are tired and gradually phasing out of a bull market and into a period in which price gains from the “market” going up had better not be a big portion of your investment return expectations.
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