What’s the Difference Between Yield and Return?Posted on March 26, 2013 by
Recently, an investor asked us to explain the difference between “yield” and “return.” When Kim and I first became real estate investors, we asked this exact same question.
Yield and return are different ends of the same stick.
A yield looks forward – it’s looking into the future. It hasn’t happened yet. It’s what you project your investment dollars to earn each year for the life of the investment.
A return looks backward – it’s looking at what your investment actually did. There’s no guesswork about what you made because everything has already happened.
To better understand yield, let’s look at an example: You buy a 12-year-old, two-bedroom, two-bath mobile home in a park. Your all-in purchase cost is $2,750. You sell this home for $8,500 with the following sale terms: $500 down, with monthly payments of $275, at 18.63% interest, for 39 months.
Now let’s figure the yield using your trusty financial calculator: N = 39; I/YR = ?; PV = -2,250; PMT = 275; FV = 0. Solving for I/YR gives you a yearly yield of 144.95%.
What does “gives you a yearly yield of 144.95%” mean? Great question! It means that you expect your $2,250 investment to $3,300 each year ($275 x 12), for 3.25 years (39 months). In other words, the first year, you should recoup your initial $2,250 investment ($2,750 purchase price – $500 down), plus make a $1,050 profit. The second year, you should make a $3,300 profit. The third year, you should make a $3,330 profit. Finally, you should make $825 in the last year of your investment ($275 x 3 months).
I want to repeat an important thing that was difficult for me to grasp when I was first learning about yields and returns: When figuring a yield or return, remember that it’s a per-year percentage, not an over-the-life-of-the-investment percentage. Early on – using the example above – I mistakenly divided 144.95% by 3.25 years to get the yield or return. THIS WAS W-R-O-N-G! The correct number is 144.95% PER YEAR!
With an investment, are your yield and return ever the same? Yes, IF the person made all his payments on time, didn’t incur any late fees and paid off the property when he was supposed to.
So are an investment’s yield and return ever different? Absolutely, because many folks don’t pay on time or they move from the property before it’s paid off.
Folks, I know today’s topic seems dull, dry and boring. But here’s the thing: We’re discussing the language of wealth-building and financial freedom. This is about YOU having the financial freedom to do what YOU want, when YOU want, where YOU want. It’s not easy stuff, but it is important stuff. Please take time to learn it. More importantly, teach it to your kids!