Yield explainer: The importance of income

What is yield?

Yield is the income return on an investment. In its simplest form, if you pay money into a bank account the bank pays you interest on the cash.

How is yield calculated?

Yield is most often expressed in percentage terms based on the investment's cost, its current market value or its face value, which makes it easier to compare the attractiveness of assets.

For example, if you buy a share worth £10 and it pays a dividend of £1 then the yield is 10%.

What is the difference between yield and return?

Yield is usually paid in the form of interest or a dividend on a quarterly, half-yearly or annual basis and ignores the capital value of an investment.

Returns take into account the capital value of an asset as well as the dividend and interest payments.

Why has income become so important?

Interest rates in most developed countries are now at or near historic lows. That means interest earned on money paid into banks and cash ISAs or invested in money markets is negligible.

Traditional sources of supposedly "safe" income, such as US, UK and German bonds, have now become prohibitively expensive to buy, while higher-yielding bonds are often deemed too risky for a conservative investor. The result has left investors hunting for good affordable yield.

Where can investors find yield?

Source: Thomson Reuters Datastream as at 10/06/2015

Source: Thomson Reuters Datastream as at 10/06/2015

Why is equity income such an important source of yield?

Equity yield can be variable whereas bond yield is fixed. In an inflationary environment, the real value of your dividend payment from your bonds will diminish over time, whereas companies have the ability to increase dividend payments.

Over long periods of time the biggest part of total returns comes from yield, when dividends are reinvested.

Why can’t I just buy the asset with the highest yield?

Investors should treat high-yielding assets cautiously. Higher yield often means more risk.

The second part in this series will explore where yield opportunities lie within European and UK equity markets.

Investors should research their investment thoroughly and consult their financial adviser.

Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.